Why Are Real Interest Rates Not Equalized Internationally?

In this study, we specify a set of sufficient parity conditions for real interest rates to be equalized internationally, what we call real interest parity (RIP). Using multivariate unit root tests, which have significantly greater power than univariate alternatives, we demonstrate that these suffici...

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Bibliographic Details
Published in:Southern economic journal 2004-10, Vol.71 (2), p.441-458
Main Authors: S. Young Chung, Crowder, William J.
Format: Article
Language:English
Subjects:
Case studies
Critical values
Determinism
Economic models
Equilibrium
Evaluation
Exchange market
Financial economics
Foreign exchange rates
Hypotheses
Inflation
Inflation rates
Interest rate parity theorem
Interest rates
International economics
Measurement
Monetary parity
Nominal interest rates
Price levels
Purchasing power
Purchasing power parity
Real exchange rates
Real interest rates
Root test
Statistics
Sufficient conditions
Time series
Trends
Variables
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Summary:In this study, we specify a set of sufficient parity conditions for real interest rates to be equalized internationally, what we call real interest parity (RIP). Using multivariate unit root tests, which have significantly greater power than univariate alternatives, we demonstrate that these sufficient conditions are not satisfied for five industrialized nations over the period of 1960-1996. We then examine each parity condition individually to shed some light on the source of the rejection of RIP. Our results suggest that no single violation can explain the failure of RIP in all cases. It does appear, however, that the Fisher relation is the least likely to violate the RIP equilibrium, whereas uncovered interest parity (UIP) appears to be the most commonly violated. This result is consistent with a nonstationary risk premium in the foreign exchange market.
ISSN:0038-4038
2325-8012
DOI:10.1002/j.2325-8012.2004.tb00649.x