The Real-Interest-Differential Model after Twenty Years

Two decades ago, Frankel (1979) reported empirical results favoring the Dornbusch (1976) overshooting model. Despite an important theoretical and empirical critique by Driskill and Sheffrin (1981), Frankel’s classic empirical results spawned a huge literature. We attempt to replicate the Frankel and the Driskill and Sheffrin results. We also offer an update and an extended critique of their work. While specialists in international finance generally accept that the initial promise of Frankel’s real-interest-differential model has not been realized, we believe that many will be surprised nevertheless by our bleak findings.