Research Discussion Papers, Bank of Finland
No 21/2002:
Nonlinear dynamics of interest rate and inflation
Markku Lanne
Abstract: According to several empirical studies, US inflation and
nominal interest rates, as well as the real interest rate, can be described
as unit root processes. These results imply that nominal interest rates and
expected inflation do not move one-for-one in the long run, which is not
consistent with the theoretical models. In this paper we introduce a
nonlinear bivariate mixture autoregressive model that seems to fit
quarterly US data (1952 Q1 – 2000 Q2) reasonably well. It is found that the
three-month treasury bill rate and inflation share a common nonlinear
component that explains a large part of their persistence. The real
interest rate is devoid of this component, indicating one-for-one movement
of the nominal interest rate and inflation in the long run and thus
stationarity of the real interest rate. Comparisons with a linear vector
autoregressive model reveal that in policy analysis the consequences of
neglecting nonlinearities can be substantial.
Keywords: nonlinear models; interest rate; inflation; cointegration analysis; (follow links to similar papers)
JEL-Codes: C32; E43; (follow links to similar papers)
31 pages, September 17, 2002
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