Real Interest Parity in New Europe

Abstract

In this paper we investigate the real interest parity condition in ten Eastern European transition countries during 1997-2009 period. Our sample is interesting for three reasons: It covers the second stage of economic transition in the aftermath of the collapse of socialism; the establishment of Euroland at the turn of the century: and enlargement of Euroland to include the Eastern European countries of Slovenia and Slovakia. The data enables us to investigate how the introduction of market mechanisms in the early nineties and the establishment and enlargement of Euroland acted on real interest rate convergence. We test the real interest parity condition with unit root test with and without structural breaks. Inflationary expectations are estimated in two ways: (i) under assumption of rational expectations with ex-post inflation rates and (ii) with ex-ante estimated inflation expectation using ARIMA/ARCH model. Preliminary results suggest that there is a strong evidence of stationarity and relatively weaker evidence of structural breaks.

Real interest rate differentials between Central and Eastern European countries and the euro area

“…Our results are, to some extent, comparable to those obtained by Sonora and Tica (2014) and Albulescu et al (2016). Similarly, we find that real interest rate differentials exhibit significant instabilities, and although in general the interest rate parity holds for the CEE countries, there are exceptions to this rule.…”

“…They conclude that the real interest parity holds for all of the then-new EU member-states, except Estonia, Latvia, and Poland. Similarly, Sonora and Tica (2014) find that up to 2009, real rates differentials among the CEE countries revealed strong irregularities, but stationarity is generally more pronounced once structural breaks are introduced. The authors also show that short-term interest rates and adaptive (model-based) expectations tend to produce stronger evidence in favour of the real interest rate parity.…”

A RE‐EXAMINATION OF REAL INTEREST PARITY IN CEECs USING ‘OLD’ AND ‘NEW’ SECOND‐GENERATION PANEL UNIT ROOT TESTS

“…can be simply considered as a risk premium. 4 Indeed, taking into account the risk premium is particularly relevant in the case of the CEECs (Sonora and Tica, 2010) or in the case of the emerging markets (Ferreira and León-Ledesma, 2007). Thus, Equation 1is a general expression of the UIP, often simplified by the omission of the risk premium, that is !…”

“…Because data on expected inflation is not readily available, unit root results are sensitive to how the inflation expectations and the real rate interest are computed (Pipatchaipoom and Norrbin, 2010). In order to assess the sensitivity of our results to the way we compute the real interest rates, we follow Cuestas and Harrison (2010) and Sonora and Tica (2010) and use exante (rational) and ex-post (fitted) inflation expectations. The former implies that we obtain expected values for future inflation.…”

“…On the contrary, Singh and Banerjee (2006) found that real interest rates in the emerging markets show some convergence in the long run, but real interest rate equality does not hold. In respect of the CEECs, Holmes andWang (2008a, 2008b), Arghyrou et al (2009), Sonora and Tica (2010), Cuestas and Harrison (2010), Su et al (2012), He et al (2013) and Baharumshah et al (2013) reached, based on diversified econometric techniques, the conclusion that the RIP is valid and that these countries should integrate the European Union: Arghyrou et al (2009) and Sonora and Tica (2010) used univariate unit root tests allowing structural breaks, Holmes and Wang (2008a) applied panel unit root tests, Holmes and Wang (2008b) employed an approach where unit roots tests are embedded within a Markov regimeswitching framework, Cuestas and Harrison (2010) and Su et al (2012) applied an univariate nonlinear unit root test, He et al (2013) employed a panel unit root test with a Fourier function while Baharumshah et al (2013) used a panel stationarity test that allows for multiple breaks. All these papers confirmed very easy the validity of the RIP theory, even if some recent researches documented, for developed countries, consistent deviation from the RIP during the 2007-2009 financial turmoil (Baba and Paker, 2009, Fong et al, 2010, Hui et al, 2011.…”