Nonlinear stationarity of real interest rates in the EMU countries

Abstract

PurposeThis paper aims to examine two hypotheses that have not been well investigated in the existing literature. One hypothesis is that the real interest rates of industrial countries tend to be mean‐reverting during the current floating exchange rate period. Another hypothesis is that the real interest rates of the countries involved in forming the Euro area are more likely to behave as nonlinear stationary series than those of other industrial countries.Design/methodology/approachThe study applies the conventional linear unit root tests and recently developed nonlinear unit root tests, as well as the tests of specifying nonlinearity in time series, to the short‐term real interest rates of 16 industrial countries.FindingsThe results of the study provide support for both hypotheses.Practical implicationsThe results imply that, having adopted target‐zone type stabilization policies for years, the central banks of European Monetary Union (EMU) countries were likely to have exercised monetary policies in a nonlinear way, especially in the process of meeting the requirements of joining EMU.Originality/valueThe study provides stronger evidence than previous studies for the theory that real interest rates of industrial countries tend to have mean‐reverting behavior. The study suggests that more active monetary policies for inflation control in the floating exchange rate period may have enhanced mean reversion in real interest rates.