Testing Real Interest Rate Parity for EU5 Countries: 200 Years of Data, Non-normality, Non-linearity and Breaks
Testing Real Interest Rate Parity for EU5 Countries: 200 Years of Data, Non-normality, Non-linearity and Breaks

Summary/Abstract: This paper examines the real interest rate parity (RIP) theory for EU5 countries (France, Germany, Italy, Spain, and the UK) versus the USA using RALS-FADF and RALS-FKSS unit root tests. The study addresses non-normality, non-linearity, and structural breaks in real interest rate differentials. Results confirm the RIP theory, indicating mean reversion of real interest rate differentials and highlighting the impact of financial integration on monetary policy independence and arbitrage opportunities. The study notes that central banks' ability to influence domestic economies through interest rates is limited due to global financial interconnectedness. The paper offers a new test based on whether interest rate differentials are non-normally distributed, also considering real interest rate non-linearity and non-normality in the analysis.

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