Wada, Tatsuma (2011): The Real Exchange Rate and Real Interest Differentials: The Role of the Trend-Cycle Decomposition. Published in: Economic Inquiry , Vol. 50, No. 4 (October 2012): pp. 968-987.
Download (512kB) | Preview
We propose an alternative model and method to reconcile the puzzling feature in the relationship between the real exchange rate and real interest rate differentials. Our simple two-country model with preset prices, along with firms’ misperception about the future exchange rate, implies that the real exchange rate follows an ARIMA(0,1,p) process. This allows us to compute the exact Beveridge-Nelson decomposition, which is a model-consistent decomposition. In accordance with our model, unit roots in the real exchange rates are found; and statistical inference is partially found to be affirmative regarding the link between the real exchange rate detrended by the Beveridge-Nelson decomposition and corresponding real interest differentials.
|Item Type:||MPRA Paper|
|Original Title:||The Real Exchange Rate and Real Interest Differentials: The Role of the Trend-Cycle Decomposition|
|Keywords:||Trend-Cycle Decomposition; Real Interest Parity; Sticky Price Model; Beveridge-Nelson Decomposition|
|Subjects:||F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
F - International Economics > F3 - International Finance > F31 - Foreign Exchange
|Depositing User:||Tatsuma Wada|
|Date Deposited:||07. Oct 2012 15:23|
|Last Modified:||22. Aug 2015 14:30|
Asea, P. K., and C. M. Reinhart. “Le Prix de l’Argent: How (Not) to Deal with Capital Inflows.” Journal of African Economies, 5(3, Supplement I), 1996, 231–71.
Balassa, B. “The Purchasing Power Parity: A Reappraisal.” Journal of Political Economy, 72, 1964, 584–96.
Baxter, M. “Real Exchange Rates and Real Interest Differentials: Have We Missed the Business Cycle Relationship?” Journal of Monetary Economics, 33, 1994, 5–37.
Baxter, M., and R. G. King. “Measuring Business Cycles: Approximate Band-Pass Filter for Economic Time Series.” The Review of Economics and Statistics, 79, 1999, 551–63.
Beveridge, S., and C. R. Nelson. “A New Approach to Decomposition of Economic Time Series into Permanent and Transitory Components with Particular Attention to Measurement of the ‘Business Cycle’.” Journal of Monetary Economics, 7, 1981, 151–74.
Brockwell, P. J., and R. A. Davis. Time Series: Theory and Methods. New York: Springer, 1991.
Campbell, J. Y., and R. H. Clarida. “The Dollar and Real Interest Rates.” Carnegie-Rochester Conference Series on Public Policy, 27, 1987, 103–40.
Devereux, M. B., and C. Engel. “Exchange Rate Passthrough, Exchange Rate Volatility, and Exchange Rate Disconnect.” Journal of Monetary Economics, 49, 2002, 913–40.
Edison, H. J., and W. R. Merick. “Alternative Approaches to Real Exchange Rates and Real Interest Rates: Three Up and Three Down.” International Journal of Finance and Economics, 4, 1999, 93–111.
Elliott, G., T. J. Rothenberg, and J. H. Stock. “Efficient Tests for an Autoregressive Unit Root.” Econometrica, 64, 1996, 813–36.
Engel, C., and K. D. West. “Exchange Rates and Fundamentals.” Journal of Political Economy, 113, 2005, 485–517.
Kwiatkowski, D., P. C. B. Phillips, P. Schmidt, and Y. Shin. “Testing the Null Hypothesis of Stationary against the Alternative of a Unit Root.” Journal of Econometrics, 54, 1992, 159–78.
Maddala, G. S., and I.-M. Kim. Unit Roots, Cointegration, and Structural Change. Cambridge, UK: Cambridge University Press, 1998.
Mark, N. C. International Macroeconomics and Finance. Malden, MA: Blackwell Publishing, 2001.
Mark, N. C., and Y.-K. Moh. “The Real Exchange Rate and Real Interest Differentials: The Role of Nonlinearities.” International Journal of Finance and Economics, 10, 2005, 323–35.
Meese, R. A., and K. Rogoff. “Was It Real? The Exchange Rate Interest Rate Relation.” Journal of Finance, 43, 1988, 933–48.
Morley, J. C. “A State-Space Approach to Calculating the Beveridge Nelson Decomposition.” Economics Letters, 75, 2002, 123–27.
Nakagawa, H. “Real Exchange Rates and Real Interest Differentials: Implication of Nonlinear Adjustment in Real Exchange Rate.” Journal of Monetary Economics, 49, 2002, 629–49.
Newbold, P. “Precise and Efficient Computation of the Beveridge–Nelson Decomposition of Economic Time Series.” Journal of Monetary Economics, 26, 1990, 453–57.
Ng, S., and P. Perron. “Lag Length Selection and the Construction of Unit Root Tests with Good Size and Power.” Econometrica, 69, 2001a, 1519–54.
Ng, S., and P. Perron. “PPP May Not Hold After All: Further Investigation.” Annals and Economics and Finance, 3, 2001b, 43–64.
Phillips, P. C. B., and P. Perron. “Testing for a Unit Root in Time Series Regression.” Biometrika, 75, 1988, 335–46.
Samuelson, P. A. “Theoretical Notes on Trade Problems.” Review of Economics and Statistics, 46, 1964, 145–54.
Schwert, G. W. “Tests for Unit Roots.” Journal of Business and Economis Statistics, 7, 1989, 147–59.
Stock, J. H. “Unit Roots, Structural Breaks, and Trends,” in Handbook of Econometrics, Vol. IV, Chapter 46, edited by R. Engle and D. McFadden. Amsterdam, The Netherlands: Elsevier, 1994, 2740–843.