Are real interest rates really nonstationary? New evidence from tests with good size and power

Abstract

In this paper, we re-examine the stationarity of international real interest rates, an issue first investigated by Rose [Journal of Finance 43(5) (1988) 1095], using a new set of unit root tests developed by Ng and Perron [Econometrica 69(6) (2001) 1519] with good size and power. Using conventional unit root tests, Rose finds that the nominal interest rate is I(1), while the inflation rate is I(0), for each of the many countries he considers, indicating a nonstationary real interest rate for each country. Using an extended sample period and the Ng and Perron unit root tests, we find that the nominal interest rate is I(1) and the inflation rate is I(0) for only three of the 16 countries we examine. For a number of countries, the Ng and Perron tests indicate that the nominal interest rate and inflation rate are both I(1), so that we need to test for cointegration in order to decipher the integration properties of the real interest rate. Using either the Ng and Perron unit root tests in conjunction with a pre-specified cointegrating vector or the Perron and Rodriguez [Residual based tests for cointegration with GLS detrended data (2001)] cointegration tests for an unspecified cointegrating vector, there is little robust evidence of cointegration. While our results are mixed, they usually provide support for the Rose finding that international real interest rates are nonstationary, albeit often for different reasons than Rose.