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Dreger, Christian
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[Journal:] The North American Journal of Economics and Finance [ISSN:] 1062-9408 [Volume:] 21 [Issue:] 3 [Pages:] 274-285
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.
Real interest parity
Nominal exchange rate regime
Panel unit roots
Common factors
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This publication was produced as part of the FINESS project, funded by the European Commission through the 7th Framework Programme under contract no. 217266 (
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