Does the nominal exchange rate regime affect the real interest parity condition?

Arbeitspapier

The real interest parity (RIP) condition combines two cornerstones in international finance, uncovered interest parity (UIP) and ex ante purchasing power parity (PPP). The extent of deviation from RIP is therefore an indicator of the lack of product and financial market integration. This paper investigates whether the nominal exchange rate regime has an impact on RIP. The analysis is based on 15 annual real interest rates and covers a long time span, 1870-2006. Four subperiods are distinguished and linked to fixed and flexible exchange rate regimes: the Gold Standard, the interwar float, the Bretton Woods system and the current managed float. Panel integration techniques are applied to increase the power of the tests, where cross section correlation is embedded via common factor structures. The results suggest that RIP holds as a long run condition irrespectively of the nominal exchange rate regime. However, adjustment towards RIP is affected by both the institutional framework and the historical episode. Half lives of shocks tend to be lower under fixed exchange rates and in the first part of the sample. Although barriers to trade and capital controls have been removed, they did not lead to lower half lives during the managed float.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: FIW Working Paper ; No. 64

Classification and Topics

• Classification: Wirtschaft ; Multiple or Simultaneous Equation Models: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models ; International Investment; Long-term Capital Movements ; Foreign Exchange ; Open Economy Macroeconomics
• Subject: Real interest parity ; nominal exchange rate regime ; panel unit roots ; common factors

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Dreger, Christian
• Event: Veröffentlichung
• (who): FIW - Research Centre International Economics
• (where): Vienna
• (when): 2010

Further information

• Handle: http://hdl.handle.net/10419/121063
• Last update: 10.03.2025, 11:42 AM CET