The Interdependence of Australian and Foreign Real Interest Rates

We assess the interdependence of the Australian and foreign (USA, Japan, UK, Canada, Germany, NZ) short-term real rates of interest using a quarterly time series: 1970(1) to 1997(4). Applying Zivot and Andrews (1992) tests for stationarity subject to structural breaks we find all series to be I(1). Structural breaks occurring in each series at different times are explained by policy changes, institutional characteristics or shocks such as the second oil crisis. Conventional bivariate cointegration tests (without breaks) provide limited evidence of interdependence, however using the Gregory Hansen (1996a,b) technique it is clear that foreign and Australian rates are interrelated once structural breaks are accommodated. Multivariate cointegration and error correction modelling confirm this finding. Policy implications are indicated.