Real exchange rates and real interest rate differentials: a present value interpretation

Hoffmann, M. and MacDonald, R. (2009) Real exchange rates and real interest rate differentials: a present value interpretation. European Economic Review, 53(8), pp. 952-970. (doi:10.1016/j.euroecorev.2009.04.013)

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Although the real exchange rate–real interest rate (RERI) relationship is central to most open economy macroeconomic models, empirical support for the relationship is generally found to be rather weak. In this paper we re-investigate the RERI relationship using bilateral US real exchange rate data spanning the period 1978–2007. Instead of testing one particular model, we build on Campbell and Shiller [1987. Cointegration tests of present-value models. Journal of Political Economy 95, 1062–1088] to propose a metric of the economic significance of the relationship. Our empirical results provide robust evidence that the RERI link is economically significant and that the real interest rate differential is a reasonable approximation of the expected rate of depreciation over longer horizons.

Item Type:Articles
Glasgow Author(s) Enlighten ID:MacDonald, Professor Ronald
Authors: Hoffmann, M., and MacDonald, R.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:European Economic Review
Published Online:22 May 2009

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