The world real interest rate: stochastic index number perspectives

In a recent paper, Gagnon and Unferth (1995). [Is there a real world intere st rate? J. Int. Money Finance 14, 845-855] test the hypothesis of real int erest rate equality by regressing real interest rates for all major countri es on dummy variables for each country and each period. We show that this m odel can be interpreted as an application of the stochastic approach to ind ex numbers. This approach leads to estimates of, and standard errors for, t he real rate for the world as a whole, which have appealing index-number in terpretations and foundations. We also extend Gagnon and Unferth's approach by weighting countries to recognise their differing importance in the worl d economy, in terms of relative GDP and trade. Weighting does not lead to a ppreciable changes in the results. However, when the WPI, which gives more prominence to goods entering into international trade, is used as the defla tor, our results indicate that real rates are equalized internationally. (C ) 1999 Elsevier Science Ltd. All rights reserved.