Academic journal article Journal of Money, Credit & Banking

Regime Changes in International Real Interest Rates: Are They a Monetary Phenomenon?

Academic journal article Journal of Money, Credit & Banking

Regime Changes in International Real Interest Rates: Are They a Monetary Phenomenon?

Article excerpt

THE TIME-SERIES properties of the U.S. real interest rate have received considerable attention in the extant empirical literature. This is not surprising, as the real interest rate plays a key role in theoretical models of consumption and investment decisions, the valuation of financial assets, and the monetary transmission mechanism. The extant empirical literature has followed an interesting path. In a well-known paper, Fama (1975) presented evidence that the U.S. real interest was constant over the 1953-71 period. This result was subsequently challenged in a number of studies (Fama and Schwert, 1977, Nelson and Schwert, 1977, Fama, 1981, Fama and Gibbons, 1982), and Mishkin (1981) rejected a constant U.S. real interest rate over the 1953-79 and 1931-52 periods. In the wake of these findings, studies such as Huizinga and Mishkin (1986) and Bonser-Neal (1990) did not assume a constant real interest rate in their empirical analyses. However, they did assume a stationary real interest rate, an assumption called into question by Schwert (1986) and Antoncic (1986). In support of a nonstationary real rate, Rose (1988) presented evidence that the null hypothesis of a unit root could not be rejected for the U.S. real interest rate, as well as the real interest rate for a large number of other industrialized countries. (1) Building on the insights in Perron (1989), Perron (1990) and Garcia and Perron (1996) argued that the U.S. real interest rate is better described as a stationary process around an infrequently shifting mean. Such infrequent regime changes in the mean real interest rate make it difficult to reject the unit root null hypothesis for the real interest rate.

Two recent studies continue in the direction of Perron (1990) and Garcia and Perron (1996). Caporale and Grier (2000) and Bai and Perron (2003) use the powerful Bai and Perron (1998, 2001, 2003) methodology to test for multiple structural breaks in the mean of the U.S. real interest rate. Both of these studies find significant evidence of three structural breaks (four regimes) in the mean of the ex post U.S. real interest rate over the 1961:1-1986:3 period. (2) In an interesting exercise, Caporale and Grier (2000) also find that these structural breaks are consistent with changes in political regimes--more specifically, changes in party control of the U.S. presidency or either branch of Congress. Caporale and Grier (2000) thus take an important step in trying to account for the apparent regime changes in U.S. real interest rates.

In the present paper, we extend the recent empirical literature on the real interest rate in two important ways. First, while Caporale and Grier (2000) and Bai and Perron (2003) focus exclusively on the U.S. real interest rate, we examine whether structural breaks in the real interest rate are limited to the U.S. or whether real interest rates in other industrialized countries are also characterized by breaks in their mean. To this end, we use the Bai and Perron methodology to test for multiple structural breaks in the ex post real interest rate for 13 industrialized countries using quarterly postwar data. Interestingly, we find that structural breaks in the mean ex post real interest rate are not an exclusively U.S. phenomenon, as almost all of the other countries that we consider exhibit significant evidence of multiple structural breaks. In fact, the timing and direction of the structural breaks are often similar across countries, indicating that the breaks may have a common source or that countries have changed policies at about the same time. Our extensive evidence of structural breaks suggests that infrequent shifts in the mean of the real interest rate are a stylized fact of international macroeconomic data.

Our second extension of the recent empirical literature is in the spirit of Caporale and Grier (2000). While Caporale and Grier (2000) focus on changes in party control of the presidency or either branch of Congress as a potential source of structural breaks in the U. …

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