International Interest Rate Linkages: a Time Varying Parameter Approach

This paper examines the issue of state contingency in interest rate linkages across the G7 economies by employing Kalman (1960,1963) filter techniques to estimate time varying parameter models of bilateral dependence. Our results show that there is convincing evidence that international linkages in interest rates vary considerably over time. There are periods when international interest rate movements are important in determining national interest rates and periods when domestic rates are unaffected by international developments. Also there is evidence that the influence of the US and Germany on the other G7 economies changes over time and during particular policy episodes. We provide a characterization of the mechanisms which might underlie our empirical results.