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Real Interest Rates and Real Exchange Rates : Evidence from Indexed Bonds

Author

Listed:
  • Douglas Laxton

    (International Monetary Fund)

  • Michael Bleany

    (University of Nottingham)

Abstract
Uncovered interest parity combined with mean reversion in real exchange rates implies a positive correlation between the real interest rate differential and the level of the real exchange rate. Previous empirical work that has attempted to test for this relationship has found little empirical support. In this paper we show that empirical tests are sensitive to measures of inflationary expectations and the real interest rate. If we employ measures of inflationary expectations and real interest rates from indexed bonds, we find that there is a significant positive correlation between real interest rates and the real exchange rate. We also show that this correlation disappears when we use the types of proxies that previous researchers have relied upon to measure inflationary expectations.

Suggested Citation

  • Douglas Laxton & Michael Bleany, 1999. "Real Interest Rates and Real Exchange Rates : Evidence from Indexed Bonds," Computing in Economics and Finance 1999 942, Society for Computational Economics.
    • Handle: RePEc:sce:scecf9:942
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    Cited by:

    1. Bhagwan Chowdhry & Richard Roll & Yihong Xia, 2005. "Extracting Inflation from Stock Returns to Test Purchasing Power Parity," American Economic Review, American Economic Association, vol. 95(1), pages 255-276, March.
    2. Dinçer Afat & Michael Frömmel, 2020. "An Alternative Version of Purchasing Power Parity," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 25(4), pages 511-517, October.
    3. Mr. Papa M N'Diaye & Mr. Douglas Laxton, 2002. "Monetary Policy Credibility and the Unemployment-Inflation Tradeoff: Some Evidence From 17 Industrial Countries," IMF Working Papers 2002/220, International Monetary Fund.
    4. Mr. Guy M Meredith & Yue Ma, 2002. "The Forward Premium Puzzle Revisited," IMF Working Papers 2002/028, International Monetary Fund.

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