Does real interest rate parity really hold? New evidence from G7 countries

Abstract

The purpose of this study is to understand the fulfillment of the real interest rate parity (RIRP) for G7 countries using panel data on short-term real interest rate differentials (RIRD). Two modern econometric approaches, sharp transition and smooth transition, are employed to examine the dynamic processes of RIRP in the work. More specifically, the novel approaches which specify Carrion-i-Silvestre et al.'s (2005) model and the Fourier function are adopted to re-examine the RIRD. Some major findings are summarized as follows. Firstly, the empirical results are remarkably consistent, even when using distinct numéraire countries or/and using alternative definitions of the real interest rates. Moreover, we obtain results indicating RIRP fulfillment in most cases, whether we adopt the panel or univariate stationarity tests. However, we fail to obtain the strong evidence in favor of RIRP by the Narayan and Popp (2010) unit root test.