A New Test of the Real Interest Rate Parity Hypothesis: Bounds Approach and Structural Breaks

We test the real interest rate parity hypothesis using data for the G7 countries over the period 1970-2008. Our contribution is two-fold. First, we utilize the ARDL bounds approach of Pesaran et al. (2001) which allows us to overcome uncertainty about the order of integration of real interest rates. Second, we test for structural breaks in the underlying relationship using the multiple structural breaks test of Bai and Perron (1998, 2003). Our results indicate significant parameter instability and suggest that, despite the advances in economic and financial integration, real interest rate parity has not fully recovered from a breakdown in the 1980s.

Structural Breaks in the Real Exchange Rate and Real Interest Rate Relationship

In this paper we empirically examine the relationship between the real exchange rate and real interest rate differentials using recent econometric methods robust to potential structural breaks. Generally, our study provides evidence of this relationship in the long-run context. More specifically, we first focus on the UK-US relationship, and interestingly find limited evidence of this long-run relationship using traditional methods. But when an approach robust to endogenously determined structural breaks is employed, we find evidence that the real interest rate differential is an important determinant of the real exchange rate. Secondly, in order to investigate the relevance of structural shifts in a more global context, we carry out multiple country analysis. While providing evidence of this long-run relationship, European data suggest that the presence of structural breaks is not very common across countries and is indeed country-specific.

Inverted Haavelmo Effects in a General Equilibrium Analysis of the Impact of Implementing the Scottish Variable Rate of Income Tax.

The Scottish Parliament has the authority to make a balanced-budget expansion or contraction in public expenditure, funded by corresponding local changes in the basic rate of income tax of up to 3p in the pound. This fiscal adjustment is known as the Scottish Variable Rate of income tax, though it has never, as yet, been used. In this paper we attempt to identify the impact on aggregate economic activity in Scotland of implementing these devolved fiscal powers. This is achieved through theoretical analysis and simulation using a Computable General Equilibrium (CGE) model for Scotland. This analysis generalises the conventional Keynesian model so that negative balanced-budget multipliers values are possible, reflecting a regional “inverted Haavelmo effect”. Key parameters determining the aggregate economic impact are the extent to which the Scottish Government create local amenities valuable to the Scottish population and the extent to which this is incorporated into local wage bargaining.

A Panel Data Investigation of Real Exchange Rate Misalignment and Growth

The paper investigates the role of real exchange rate misalignment on long-run growth for a set of ninety countries using time series data from 1980 to 2004. We first estimate a panel data model (using fixed and random effects) for the real exchange rate, with different model specifications, in order to produce estimates of the equilibrium real exchange rate and this is then used to construct measures of real exchange rate misalignment. We also provide an alternative set of estimates of real exchange rate misalignment using panel cointegration methods. The variables used in our real exchange rate models are: real per capita GDP; net foreign assets; terms of trade and government consumption. The results for the two-step System GMM panel growth models indicate that the coefficients for real exchange rate misalignment are positive for different model specification and samples, which means that a more depreciated (appreciated) real exchange rate helps (harms) long-run growth. The estimated coefficients are higher for developing and emerging countries.

Revisiting the Dollar-Euro Permanent Equilibrium Exchange Rate: Evidence from Multivariate Unobserved Components Models

We propose an alternative approach to obtaining a permanent equilibrium exchange rate (PEER), based on an unobserved components (UC) model. This approach offers a number of advantages over the conventional cointegration-based PEER. Firstly, we do not rely on the prerequisite that cointegration has to be found between the real exchange rate and macroeconomic fundamentals to obtain non-spurious long-run relationships and the PEER. Secondly, the impact that the permanent and transitory components of the macroeconomic fundamentals have on the real exchange rate can be modelled separately in the UC model. This is important for variables where the long and short-run effects may drive the real exchange rate in opposite directions, such as the relative government expenditure ratio. We also demonstrate that our proposed exchange rate models have good out-of sample forecasting properties. Our approach would be a useful technique for central banks to estimate the equilibrium exchange rate and to forecast the long-run movements of the exchange rate.

On the real effects of financial pressure: Evidence from euro area firm-level employment during the recent financial crisis.

Using a large panel of unquoted euro-area firms over the period 2003-11, this paper examines the impact of financial pressure on firms’ employment. The analysis finds evidence that financial pressure negatively affects firms’ employment decisions. This effect is stronger during the 2007-2009 financial crisis, especially for firms in the periphery area compared to their counterparts in the core European economies. We also find that impact of financial pressure on employment is more potent for firms classified as financially constrained and operating in periphery economies during the financial crisis.