THE PERSISTENCE OF REAL INTEREST DIFFERENTIALS - A KALMAN FILTERING APPROACH

This paper applies Kalman filtering techniques to estimate the persistence of ex ante real interest differentials. Identification results for state space models applicable in other contexts are presented and exploited in the model estimation. Ex ante real interest differentials for the period 1973-1987 are found to be relatively short-lived and mean-reverting to zero, thus providing empirical support for theoretical models of economic interdependence characterized by real rate equality in the long-run steady state. For the sample considered, the variability of the differentials relative to the U.S. is found to be larger than that relative to Germany.