Convergence in Interest Rates and Inflation Rates: Across Countries and Over Time

Abstract

This study examines the relationship between interest rates and inflation rates for ten countries during the period 1974-1995. Monthly end-of-month Euro-deposit rates and inflation rates are used, spanning a spectrum of maturity dates ranging from one month to one year. The recent cointegration testing procedure of Johansen and Juselius is employed. We find considerable evidence of a unique cointegrating relationship between nominal interest rates of EMS countries, the U.S. and Canada, and the U.S., Germany, and Japan. No similar relationship is obtained between inflation rates of these countries with one exception, namely the U.S. and Canada. We interpret these results as suggesting that there exists convergence in inflation but not in interest rates. The conclusions also mean that, if interest rates represent an indicator of monetary policy, the countries in our sample have attempted to implement independent policies but not to an extent which, at least during the sample in question, produced divergent trends in inflation.

JEL Classification: E43, F30