Real interest rate parity under regime shifts and implications for monetary policy

We use recently developed cointegration tests that determine the regime shi ft endogenously to test for bilateral real interest rate convergence (real interest rate parity) in the G7 against the USA in the 1974 -95 period, In contrast with previous studies that employed classical regression analysis and standard cointegration tests, our innovative approach provides strong e vidence in favour of bilateral real interest rate convergence between the U SA and several countries in our sample, in particular for short-term real i nterest rates. Our results highlight the fact that For a number of countrie s in our sample (Canada and the UK) monetary policy can act as a stabilizat ion policy tool through its effect on domestic long-term real interest rate s, while for others (France and Germany) long-term real interest rate chang es are influenced by the US monetary policy stance.