Interest Rate Convergence Research Articles

Why was the euro weak? Markets and policies

Against all odds, the euro turned out to be a weak currency. We argue that this outcome can readily be explained by the policy-mix that was chosen at the onset of the period: tight fiscal policies following the convergence mechanism that was imposed by the Maastricht treaty and loose monetary policy that resulted from the convergence of interest rates to the lower point of the spectrum. We investigate this outcome empirically and show that the euro's weakness can be understood as the result of an excess supply in the zone, which is channelled abroad in the usual beggar my neighbor way.

Real Interest Rate Parity under Regime Shifts and Implications for Monetary Policy

We use recently developed cointegration tests that determine the regime shift endogenously to test for bilateral real interest rate convergence (real interest rate parity) in the G7 against the USA in the 1974–95 period. In contrast with previous studies that employed classical regression analysis and standard cointegration tests, our innovative approach provides strong evidence in favour of bilateral real interest rate convergence between the USA and several countries in our sample, in particular for short-term real interest rates. Our results highlight the fact that for a number of countries in our sample (Canada and the UK) monetary policy can act as a stabilization policy tool through its effect on domestic long-term real interest rates, while for others (France and Germany) long-term real interest rate changes are influenced by the US monetary policy stance.

International capital flows and convergence in the neoclassical growth model

To analyze how capital mobility affects economic growth and convergence, this paper will use the analytical solution to the neoclassical growth model with a constant saving rate, beginning with the closed-economy Solow growth model. An introduction to international capital flows will follow. In an open economy, free capital mobility assures an instantaneous convergence in interest rates that, under a perfect competence situation, implies the instantaneous convergence in income levels among homogeneous countries. Taking into account this question and to reconcile these results with empirical evidence, that is, with the gradual convergence observed, the assumption is introduced that in spite of free capital mobility, there are international credit restrictions. In this case, we will show how the rate of convergence depends on the international capital inflows received.

Interest rate spreads implicit in options: Spain and Italy against Germany

The options premiums are frequently used to obtain probability density functions (pdfs) for the prices of the underlying assets. When these assets are bank deposits or notional Government bonds it is possible to compute probability measures of future interest rates. Recently, in the literature there have been many papers presenting methods of how to estimate pdfs from options premiums. Nevertheless, as far as we know, the estimation of probabilities of forward interest rate functions is an issue that has not been analysed before. In this paper, we propose such a method, that can be used to study the evolution of the expectations about interest rate convergence. We look at the cases of Spain and Italy against Germany, before the adoption of a single currency, and conclude that the expectations on the short-term interest rates convergence of Spain and Italy vis-a-vis Germany had a somewhat different trajectory, with higher expectations of convergence for Spain.

European Economic and Monetary Cooperation from an Historical Perspective

Analyse the issues related to the European Economic and Monetary Union and positive and negative impacts of the single European currency Euro launched on 1st January, 1999, on the economic and political environment in Europe. Launching of Euro strengthens Europe's bargaining position vis-a-vis the United States and other countries. Creation of new financial instruments and convergence of inflation and interest rates will have an impact on investment decisions and cross-border flows will increase the size of the markets.

European Equity Markets and the EMU

During the 1980s, country effects were larger than industry effects in the equity markets of Western Europe. This phenomenon continued for the countries of the European Monetary Union in the 1993–98 period despite the convergence of interest rates and the harmonization of fiscal and monetary policies following the Maastricht Treaty of 1992. Today, no evidence supports the disappearance of differences between EMU countries' equity returns.

Testing For Real Interest Rate Convergence In European Countries

We use cointegration tests that determine endogenously the regime shift to test for bilateral short‐term and long‐term real interest rate convergence in the European Monetary System in the 1979–1993 period. The results of these tests provide strong evidence in favour of bilateral real interest rate convergence between Germany and several countries in our sample, particularly for long‐term real interest rates. This result carries the important policy implication that in several European countries monetary policy has lost some of its effectiveness as a stabilisation policy tool.

Interest Rate Volatility, Contagion and Convergence: An Empirical Investigation of the Cases of Argentina, Chile and Mexico

(1998). Interest Rate Volatility, Contagion and Convergence: An Empirical Investigation of the Cases of Argentina, Chile and Mexico. Journal of Applied Economics: Vol. 1, No. 1, pp. 55-86.

European Equity Markets and EMU: Are the Differences Between Countries Slowly Disappearing?

During the 1980s country effects have been larger than industry effects in the equity markets of Western Europe. This has continued to be the case for the EMU countries in the 1993-1998 period, despite the convergence of interest rates and the harmonization of fiscal and monetary policies following the Maastricht Treaty of 1992. As of now, there is no evidence that the differences between countries have disappeared.

Tests for interest rate convergence and structural breaks in the EMS

We use a new test for cointegration that allows for structural breaks in the cointegrating relationship to test for bilateral interest rate convergence in the European Monetary System. Contrary to previous studies that employed standard cointegration tests, we find strong evidence for convergence between German nominal interest rates and interest rates in four other EMS countries in the 1979–1995 period.

La integración monetaria y financiera. Lecciones de la Unión Europea

This article discusses the integration process of the European Union, stressing the financial aspects, and also discusses the need for a single currency as a further step in that process. The analysis of the financial integration evaluates the existence of interest rate parity and convergence. The main result is that both parity and convergence seem to have been achieved, but only for long run interest rates and just recently. The persistence of important differences between short run interest rates could cause some troubles and it would be showing the skepticism of the single currency successful. Also, the article carries out that the implementation of the single currency will reduce the autonomy of the fiscal policy, and mainly the tax policy, something that appears unwanted by the authorities of the country members of the European Union that have avoided to establish agreements about that.

Long-Term Interest Rate Convergence in Europe and the Probability of EMU

LONG-TERM INTEREST RATE CONVERGENCE IN EUROPE AND THE PROBABILITY OF EMU by Ignazio Angeloni and Roberto Violi (*) Abstract Using a simple method, based on forward interest spreads, we analyse the recent movements in the 10-year yield differentials between three currencies (Italian lira; Spanish peseta; Swedish krona) and the DM in order to gauge the extent to which the reduction in these differentials was due to market arbitrage triggered by the expectation of EMU or to more “fundamental” factors (lower inflationary expectations; improved fiscal outlook). We find that most of that reduction cannot be directly explained by EMU expectations, though EMU is likely to have had an indirect influence by providing an incentive for faster convergence on inflation and fiscal performance. As a by-product of our analysis, we compute estimates of the market probabilities of EMU taking place and of each country joining at different dates (1999 and 2002).

International convergence of short-term and long-term interest rates: Theory and empirical tests

International convergence of short-term and long-term interest rates: Theory and empirical tests

Convergence in Interest Rates and Inflation Rates Across Countries and Over Time

We examine the relationship between interest rates and inflation rates for 10 countries during the period 1974–95. We find evidence of a unique cointegrating relationship between nominal interest rates of European Monetary System (EMS) countries, the US and Canada, and the US, Germany, and Japan. No similar relationship is obtained between inflation rates with one exception, namely, that between the US and Canada. We interpret these results as convergence in inflation but not in interst rates. Hence, if interest rates represent an indicator of monetary policy, the countries considered have attempted to implement independent policies but not to an extent which produced divergent trends in inflation.

Fiscal Discipline and the Question of Convergence of National Interest Rates in the European Union

In this paper, interest-rate convergence in Europe is related to the behavior of integrated federal political systems. Our main results are: Before the final fixing of exchange rates, national interest rates will converge toward the German bond yield in countries eligible to become EMU members in part because no-bailout clauses are not credible in the starting period of EMU. Should such clauses become more credible after 2002 because the EU government and its redistributive mechanisms remain weak, the “market-discipline hypothesis” has a greater chance to apply. But it may still prove unequal to the task of discouraging excessive fiscal deficits on its own.

Interest rate convergence, capital controls, risk premia and foreign exchange market efficiency in the EMS

This paper examines interest rate convergence between Germany and the other EMS countries. We argue that earlier tests of convergence based on cointegration are not informative, because cointegration only implies that a linear combination of interest rates is stationary. We show that a conclusive judgment about convergence can be made if interest rate differentials exhibit a trend towards zero during the period when convergence occurred, and if the cointegrating vector has unit coefficients. We then establish that convergence has taken place in the “hard” EMS period. We also attempt to identify the sources of nonstationarities in interest differentials by examining the existence of stochastic or deterministic trends in the expected rate of depreciation and in the risk premium. Finally, the possibility of market inefficiencies is discussed.

Convergence of inflation and interest rates prior to EMU: An empirical analysis

This paper assesses the rationale of inflation and interest rate convergence as a criterion for the passage to the final stage of EMU by analyzing the consequences of irrevocably fixing exchange rates while member states' performances are still diverging, on the basis of simulations conducted with the NIESR macroeconometric model (GEM). The results suggest that the fixing of exchange rates may produce spillover effects from high- to low-inflation countries under certain circumstances, and that if the Union's monetary authority seeks to counter these effects, the low-inflation countries may suffer a reduction of their output.

Liberalized Portfolio Capital Inflows in Emerging Markets: Sterilization, Expectations, and the Incompleteness of Interest Rate Convergence

This paper examines interest rates in nine Latin American and East Asian countries during the period 1987–1994. The goal is to discover why interest rates remained high, failing to converge to US levels, despite capital market liberalization and a resurgence of portfolio capital inflows during the second half of this sample period. Related questions are whether portfolio capital flows are strong enough to equalize expected returns between these ‘emerging markets’ and the US, and whether there is any scope left for the authorities to sterilize inflows. The conclusion of the study is that the largest single component of the gap in interest rates is expectations of depreciation of the local currencies against the dollar. The key to the analysis is the use of survey data on exchange rate forecasts by market participants. Indicative of integrated financial markets, we also find a big effect of US interest rates on local interest rates, and a highly significant degree of capital flow offset to monetary policy.

Interest rate linkages within the European Monetary System: an alternative interpretation

In this note the empirical evidence presented by Karfakis and Moschos (1990) and Katsimbris and Miller (1993) on interest rate linkages in the EMS is reinterpreted and their finding of non-stationarity of interest rate differentials in the EMS is rationalized. It is argued that their results are not counterintuitive if it is taken into account that the integration of financial markets in the EMS has been a gradual process, which has implied slow convergence of interest rates to German levels. Such a dynamic process accounts for the non-stationarity of interest rate differentials. However, the argument that standard parity conditions require pairwise cointegration of interest rates is a valid one once convergence has been achieved.

Price and monetary convergence in currency unions: The franc and rand zones

Theory suggests that a currency union will impose significant macroeconomic disciplines on its members. The law of one price, for example, should lead to convergence of price levels, at least for what may be regarded as tradeable goods. Likewise arbitrage would imply convergence of interest rates. This paper looks at the two main surviving currency unions, the franc and rand zones in Africa, to see whether and to what extent these generally accepted propositions find confirmation in the data. Each of the African currency unions has a dominant or ‘core’ member, France in the case of the franc zone and the Republic of South Africa (RSA) in the case of the rand zone. Our focus is on the small members in the ‘periphery’ and for them there is the additional presumption that inflation and interest rates will be imported from the core. Despite some rather wide short-run divergences, and although convergence is slow, we find that, in the long-run, consumer price inflation is largely determined in the core. The limited evidence available suggests that uncontrolled interest rates also converge to core country levels (JEL F31).