Real interest rates: nonlinearity and structural breaks


Omay T., Corakci A., Emirmahmutoglu F.

EMPIRICAL ECONOMICS, vol.52, no.1, pp.283-307, 2017 (SSCI) identifier identifier

  • Publication Type: Article / Article
  • Volume: 52 Issue: 1
  • Publication Date: 2017
  • Doi Number: 10.1007/s00181-015-1065-1
  • Journal Name: EMPIRICAL ECONOMICS
  • Journal Indexes: Social Sciences Citation Index (SSCI), Scopus
  • Page Numbers: pp.283-307
  • Keywords: Smooth break, Panel unit root, Cross-sectional dependence, Nonlinearity, Real interest rate, UNIT-ROOT TESTS, MULTIFACTOR ERROR STRUCTURE, ASYMMETRIC ADJUSTMENT, HETEROGENEOUS PANELS, PHILLIPS-CURVE, MEAN REVERSION, EXCHANGE-RATES, INFLATION, MODELS, CONSUMPTION
  • Ankara Haci Bayram Veli University Affiliated: No

Abstract

Real interest rate is a crucial variable that determines the consumption, investment and saving behavior of individuals and thereby acts as a key policy tool that the central banks use to control the economy. Although many important theoretical models require the real interest rates to be stationary, the empirical evidence accumulated so far has not been able to provide conclusive evidence on the mean reverting dynamics of this variable. To resolve this puzzle we re-investigate the stochastic nature of the real interest rates by developing unit root tests for nonlinear heterogeneous panels where the alternative hypothesis allows for a smooth transition between deterministic linear trends around which stationary asymmetric adjustment may occur. When the newly developed panel unit root tests are applied to the real interest rates of the 17 OECD countries, we were able to uncover overwhelming empirical support in favor of mean reversion in the short-run and long-run real interest rates. Therefore, these results show that the conclusions drawn from a miss-specified test that ignores the presence of either nonlinearity, structural breaks or cross sectional dependence can give quite misleading results about the stochastic behavior of the real interest rates.