Working Paper No. 2
By Andy Haldane and Mahmood Pradhan
Current discussions on Economic and Monetary Union (EMU) in Europe have stressed the need for enhanced integration of goods and factor markets as a precondition of moving as costlessly as possible to a single currency system. The real interest differential - and hence tests of real interest parity - provide a summary measure of the degree of residual integration necessary such that these conditions are met. Empirical tests suggest a rejection of real interest parity among European Monetary System (EMS) member countries, at least during recent years. Further, a decomposition of the differential suggests that imperfect integration of goods markets, as reflected in a failure of ex-ante PPP, is largely responsible for this findIng.