Long-run interest rate convergence in Poland and the EMU
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1 Working Papers No. 21/2013 (106) ŁUKASZ GOCZEK DAGMARA MYCIELSKA Long-run ineres rae convergence in Poland and he EMU Warsaw 2013
2 Long-run ineres rae convergence in Poland and he EMU ŁUKASZ GOCZEK Faculy of Economic Sciences, Universiy of Warsaw DAGMARA MYCIELSKA Faculy of Economic Sciences, Universiy of Warsaw [eabsrac The aim of he aricle is o examine he degree of he long-run ineres rae convergence in he conex of Poland's joining he EMU. In his perspecive, i is frequenly argued ha he expecaions of Poland's paricipaion in he EMU should manifes hemselves in long-run ineres rae convergence. This should be visible in he long-run fall of ineres rae risk premium in Poland. In conras, he paper raises he quesion of he acual speed of such convergence and quesions he exisence of his phenomenon in Poland. Confirmaion of he hypohesis concerning slow convergence in he risk premium is essenial o he analysis of coss of he Polish accession o he EMU. The main hypohesis of he aricle is verified using a Vecor Error-Correcion Mechanism model of an Uncovered Ineres Rae Pariy and several parameric hypoheses concerning he speed and asymmery of adjusmen. Keywords: empirical analysis, Eurozone, ineres rae convergence, moneary union JEL: E43, E52, E58, F41, F42, C32 Working Papers conain preliminary research resuls. Please consider his when ciing he paper. Please conac he auhors o give commens or o obain revised version. Any misakes and he views expressed herein are solely hose of he auhors.
3 1. Inroducion I is frequenly argued ha he expecaions of counry's paricipaion in he moneary union (e.g. European Moneary Union, EMU) should manifes hemselves in long-run ineres rae convergence. According o he heory, a successful inegraion of he accession counry ough o be refleced in he sabiliy of he converging counry s financial sysem. This should be visible in many areas - converging inflaion, converging ineres raes, and diminishing exchange rae risk premium over he corresponding variables in a common currency area. If he risk premium is sill posiive or negaive, bu flucuaes wih low or diminishing variance ha migh be reaed as an argumen in favor of economic inegraion. However, he recen euro zone crisis has pushed he exchange rae premium in he EMU counries back o heir pre-accession levels. During his ime he markes have learned o differeniae asses of he EMU counries denominaed in euro. In his paper we wan o assess he influence of he crisis on he risk premium on polish zloy as compared o euro. The paper raises he quesion of he acual speed of risk premium convergence in he case of Poland. The main hypohesis saes ha he risk premium convergence is slow bu sable risk premium migh be inerpreed in favor of Poland s accession o he EMU. Tha would also sugges he high level of moneary inegraion beween Poland and EMU. The main hypohesis of he paper is verified using coinegraion esing of nominal ineres raes and exchange raes in Poland and he EMU. Based on he resuls of coinegraion esing a Vecor Error Correcion Mechanism (VECM) model is consruced showing a seady sae ineres rae pariy coinegraion equilibrium. The model is hen used o es several parameric hypoheses concerning he speed and asymmery of adjusmen beween ineres raes in Poland and EMU ha allow deermining he risk premium in he domesic economy over he oher currency area. The firs par of he aricle describes he empirical sraegy and parameric hypoheses ha are verified using he VECM model. The second par presens he resuls concerning hisorical relaionships beween ineres raes in Poland and he EMU. The aricle concludes wih a discussion of policy implicaions of he resuls in he conex of Poland's joining he Eurozone. The research shown in his paper is an aemp o complemen he exising sae of he ar in he field of economic research on he benefis and coss of Poland's adopion of he euro. 2. Empirical mehodology and specificaion The fundamenal argumen of arge zone models (Krugman, 1979) is ha a emporary deviaion of domesic from foreign ineres raes is possible only if he arge zone is credible in is desire o arge primarily domesic shocks. Hence, ineres raes may diverge persisenly from he equilibrium of he uncovered ineres rae pariy under a flexible exchange rae regime only if he domesic policies of upholding he floaing exchange rae are credible. Therefore he size and he lengh of he deviaion from he pariy can be used o measure he degree of risk premium in he domesic economy over inernaional ineres raes. Considering he Polish case i is expeced ha his premium is posiive, bu i is exhibiing a negaive rend due o he expecaions of Poland's joining he EMU. In oher words, his diminishing risk premium can be hough of as nominal ineres rae convergence mechanism. Boh of hese asserions (posiive exchange risk premium and ineres rae convergence) are esable empirically. To his end i is possible o employ coinegraion esing beween ineres raes
4 in boh areas and he exchange rae beween hem. This is allowed for by he fac ha all of he ime series are I(1) which was confirmed by resuls of KPSS uni roo es, shown in Table 2. In he case of variables which are inegraed of he same order i is possible o invesigae he exisence of a long-run relaionship, which relaes o he macroeconomic concep of a seady-sae dynamic equilibrium. This can be deermined in he daa using ess for he exisence of a coinegraing vecor for he ineres raes. Based on his assumpion, he PLN/EUR exchange rae and he 3-monh WIBOR and EURIBOR ineres raes are used during he period saring from April he 1s 2000 o April 1s 2013 (afer he floaaion of zloy and joining he EU by Poland) wih daily frequency. Figure 1 plos he hree variables WIBOR_3M_O EURIBOR_3M_O EURPLN_O Figure 1. Three monh WIBOR and EURIBOR ineres raes and he PLN/EUR exchange rae Source: Own calculaions. The empirical model follows Reade, Volz (2010), Goczek, Mycielska (2013). Le us consider hree ime series for domesic and inernaional ineres raes and he exchange rae ha form a rivariae daa vecor X given by: r X r * (1) d The domesic inerbank ineres rae (WIBOR_3M) is denoed by r, he inernaional inerbank ineres rae (EURIBOR_3M) is denoed by r *, he exchange rae(eurpln) is denoed by d *. The hree variables are used o form a Vecor Auoregressive (VAR) model described by he following equaion:
5 X X u 0 1 i 1 i 1 K (2) dimension, where he error erm i 2 u N(0, ) is uncorrelaed over, he daa vecor X is p T is he deerminisic coefficien marix (consan and rend) of a dimension p p. If he daa are non-saionary in levels and saionary in firs differences, hen he equaion (2) can be rearranged o form a vecor error correcion mechanism: K 1 * * 1 i i i 1 X X X u (3) where: * * K K X 1 ( X 1,1, )', (, 0, 1), i 1 i I and i j i 1 j. For he ease of exposiion, he coefficiens for he lagged regressors and he deerminisic erms were grouped ogeher which is similar o aking of his problem in mos economeric packages. Under he assumpion ha X ~ I(1) and u I(0), he marix is of reduced rank for he equaion (3) o be balanced. If is of reduced rank, hen here exiss p r marices and such ha ' and he equaion (3) can be ransformed o: K 1 * ' 1 i i i 1 X X X u. (4) * The erm ' X is he coinegraing vecor showing he seady sae relaionship beween 1 he ineres raes. In he conex of ineres raes hose are linear combinaions, which hemselves are non-saionary, bu he relaionship beween hem is saionary wih a seady sae coinegraing vecor forming uncovered ineres rae pariy. If he marix is of rank one, his means ha a single coinegraing vecor exiss, and ' is 1 p +2 (consan and rend in he coinegraing relaionship). Then he coinegraing relaion can be rewrien o be: 1 ' X (,,,, ) r r r d (5) * * * r d If i is found during he empirical analysis of he wo ineres raes, ha he rank is indeed one, his means ha here exiss a single coinegraion vecor - a single seady sae relaionship. This is an indicaion of upholding of he uncovered ineres raes in he wo currency areas. However, i could be argued ha his relaionship does no have bilaeral causaliy or feedback properies. From a heoreical viewpoin i is very probable ha he Poland's arge zone is no credible enough for domesic ineres rae deviaion from inernaional raes o hold over prolonged periods, since he Polish economy is financially and economically inegraed wih he Eurozone. In conras, an inverse
6 relaionship is quie unlikely o hold - i seems impossible ha he Polish ineres raes influence he currency area orders of enormiy larger han he Polish economy. The properies of hese relaionships can be hen verified using parameric es concerning coefficiens from he marix. The saisical significance and he sign of he coefficiens indicae how a given ineres rae reacs o a disequilibrium from he coinegraing vecor. In he analyzed case i is herefore expeced ha he WIBOR rae changes owards he seady sae relaion wih he EURIBOR and no he oher way around. This is esable hrough he hypohesis ha he adjusmen coefficien is insignifican in he EURORIBOR equaion and significan in he WIBOR equaion. I is expeced ha he inerbank marke in he smaller economy is going o exhibi a higher risk premium. This is modeled using he inercep and rend in he coinegraing equaion. A formal es concerning he sign and significance of his coefficien allows his hypohesis o be esed in he dae. A he same ime i could be argued ha because of he expeced Poland's enry o he EMU and he inensifying financial inegraion of Poland ino European capial markes since he early 1990s, his premium is expeced o fall. This should be seen in he long run convergence of he wo ineres raes. This phenomenon can be measured using linear rend erm coefficien in he coinegraing equaion. Summing up he discussion - he parameric hypoheses can be reduced o he following lis: 1. H 0 : is of rank one - here exiss a long run seady-sae relaionship beween he ineres raes in Poland and he Eurozone. 2. H 0 : es of he exisence of a posiive risk premium in Poland. 3. H 0 : no long-run convergence in risk premium beween he wo areas. Empirical resuls follow in he nex chaper. 2. Empirical model resuls The empirical analysis sared wih Granger Causaliy esing in order o deermine he casual relaions visible in he daa. Based on he resuls, presened in Table 2, i was concluded ha here exiss a casual relaionship beween he hree variables of ineres, WIBOR, EURIBOR and EURPLN. Based on hese preliminary resuls i can be hypohesized ha WIBOR and EURIBOR exhibi a posiive feedback relaionship while he exchange rae is influenced by WIBOR only and ha EURIBOR is an exogenous variable ha impacs WIBOR in he Granger sense, while oher variables do no exhibi causaliy in Granger sense on EURIBOR. These empirical relaions poin oward uncovered ineres rae relaionship beween larger and smaller open economies.
7 Table 1. Pairwise Granger Causaliy Tess (Lags 30) Null Hypohesis: Obs F-Saisic Prob. EURIBOR_3M_O does no Granger Cause WIBOR_3M_O E-10 WIBOR_3M_O does no Granger Cause EURIBOR_3M_O E-10 EURPLN_O does no Granger Cause WIBOR_3M_O WIBOR_3M_O does no Granger Cause EURPLN_O EURPLN_O does no Granger Cause EURIBOR_3M_O EURIBOR_3M_O does no Granger Cause EURPLN_O Source: Own calculaions. As a second sep, Uni Roos ess were run o check he saionariy of he ime series in he rivariae daa sample. Kwiakowski e al. (1992) KPSS Uni Roo es was used o deermine he exisence of uni roos so he order of inegraion of he invesigaed ime series could be seleced. This es was used as a more robus alernaive o he more common ADF es. I was deermined ha all of he invesigaed series are inegraed of order one, hough WIBOR was a borderline I(2) process. This however is highly unlikely from he heoreical poin of view. 1 Table 2 presens hese resuls in deail. Table 2. KPSS Uni Roo Tes WIBOR_3M EURIBOR_3M EURPLN KPSS es saisic for he series in levels Asympoic criical values*: 1% % % KPSS es saisic for he series in firs differences Asympoic criical values*: 1% % % Inegraion order a 1%: I(1) I(1) I(1) Source: Own calculaions. The analysis of he daa generaing process wen furher on o analyze simple VAR model. The reason for his analysis was o deermine he number of lags necessary o perform an effecive Johansen Coinegraion es. The lag lengh selecion was based on he Schwarz Informaion Crierion o penalize large over indenified models. Under his crierion lag lengh of hree was seleced. Based on his wo versions of he Johansen Coinegraion Tes were run (he race rank es and he maximum eigenvalue es) in order o deermine he rank of he marix. Table 3 liss he resuls of boh ess. One seady sae coinegraing relaionship was found wih a very large saisical significance. This precludes any possible errors coming from he "noise" from daily frequency of observaions. Similar ess were run for weekly and monhly daa obaining same resuls. This confirms he firs hypohesis of he aricle - here exiss an uncovered pariy relaion beween ineres raes in Poland and he EMU. 1 Acually from he economic heoreical poin of view ineres raes should be saionary, his behavior is however no seen in he daa on ineres raes. See a discussion and empirical resuls in Goczek, Mycielski (2013).
8 Table 3. Johansen Coinegraion Tes Resuls Unresriced Coinegraion Rank Tes (Trace) Hypohesized Trace 0.05 No. of CE(s) Eigenvalue Saisic Criical Value Prob.** None * A mos A mos E Unresriced Coinegraion Rank Tes (Maximum Eigenvalue) Hypohesized Max-Eigen 0.05 No. of CE(s) Eigenvalue Saisic Criical Value Prob.** None * A mos A mos E Source: Own calculaions. Max-eigenvalue es indicaes 1 coinegraing eqn(s) a he 0.05 level * denoes rejecion of he hypohesis a he 0.05 level **MacKinnon-Haug-Michelis (1999) p-values Based on Johansen Tess resuls a VECM model was consruced wih an inercep and rend in he coinegraing equaion. The coinegraing vecor of he model is presened in he Table 4. The esimaed coinegraing equaion relaing a seady sae long-run relaionship exhibis he well known uncovered ineres rae pariy condiion. The seady sae relaionship exhibis a posiive consan (noe ha he Coinegraing Equaion from Table 4 is se o be 0), which confirms he second hypohesis of he empirical invesigaion. Table 4. Coinegraing Vecor Esimaes Coinegraing Eq: CoinEq1 EURPLN_O(-1) WIBOR_3M_O(-1) ( ) [ ] EURIBOR_3M_O(-1) ( ) [ (6.2E-05) [ ] C Source: Own calculaions. Moreover, here exiss a significan negaive rend relaing o diminishing exchange rae premium. however, hough significan saisically, his negaive rend is really small in economic significance erms aking ino accoun he size of he ineres raes. This implies a very slow convergence in he exchange rae premium in Poland and Eurozone - he esimaed coefficien on
9 he rend erm implies a convergence of 1 p.p over 8 years. Therefore, he verificaion of he hird hypohesis of he aricle - of ineres rae convergence - has brough mixed resuls. While here is convergence in saisical erms, in pracical economic erms he adjusmen is very slow. Table 5. VAR par of he VECM Esimaes Error Correcion: D(EURPLN_O) D(WIBOR_3M_O) D(EURIBOR_3M_O) CoinEq ( ) ( ) ( ) [ ] [ ] [ ] D(EURPLN_O(-1)) ( ) ( ) ( ) [ ] [ ] [ ] D(EURPLN_O(-2)) ( ) ( ) ( ) [ ] [ ] [ ] D(EURPLN_O(-3)) ( ) ( ) ( ) [ ] [ ] [ ] D(WIBOR_3M_O(-1)) ( ) ( ) ( ) [ ] [ ] [ ] D(WIBOR_3M_O(-2)) ( ) ( ) ( ) [ ] [ ] [ ] D(WIBOR_3M_O(-3)) ( ) ( ) ( ) [ ] [ ] [ ] D(EURIBOR_3M_O(-1)) ( ) ( ) ( ) [ ] [ ] [ ] D(EURIBOR_3M_O(-2)) ( ) ( ) ( ) [ ] [ ] [ ] D(EURIBOR_3M_O(-3)) ( ) ( ) ( ) [ ] [ ] [ ] C ( ) ( ) ( ) [ ] [ ] [ ] R-squared Adj. R-squared Sum sq. resids S.E. equaion F-saisic Log likelihood Akaike AIC Schwarz SC Deerminan resid covariance (dof adj.) 6.04E-10 Deerminan resid covariance 5.98E-10 Log likelihood Akaike informaion crierion Schwarz crierion Source: Own calculaions
10 The model has passed all relevan diagnosics. Mos imporanly i was sable as he Figure 2 shows (he error correcion mechanism imposes one Uni Roo in he model). Figure 2. VECM Sabiliy - AR Roos Source: Own calculaions. Finally, he coinegraing equaion has been ploed in he Figure 3. Based on he visual inspecion, he residuals exhibi saionary behavior, as seen in he Johansen Tes resul. Figure 3 Coinegraing relaion Source: Own calculaions.
11 Conclusions The main hypohesis of he aricle has been confirmed. Since he Euro Area counries share a common currency, exchange-relaed premium differenials can, by definiion, no longer exis in heory, and nominal ineres raes on asses wih similar characerisics canno diverge significanly. This resul have wo explanaions - one is ha he Polish accession o he EMU is no seen as credible by he inernaional invesors. The second explanaion is ha he banking secor in Poland is seen as significanly less rusworhy han is European counerpar, hence higher credi risk.
12 Lieraure Goczek, Ł., D. Mycielska, (2012). Realizacja celu inflacyjnego, czy obawa przed płynnością? Uwarunkowania kursowe w Polsce w przededniu przyjęcia euro, [w:] Where is he Eurozone Heading? red. J. Górski, K. Opolski, Warszawa, WNE NBP. Goczek, Ł., D. Mycielska, (2013). Ready for euro? Empirical sudy of he acual moneary policy independence in Poland, WNE Working Papers nr 13/2013. Goczek, Ł, J. Mycielski (2013). "Modelowanie sóp procenowych w Polsce - esy isnienia pierwiaska jednoskowego ze srukuralnym załamaniem," [w:] Innowacje i implikacje inerdyscyplinarne, red. Zbigniew Zieliński PITWIN, Kielce, Juselius, K., (2007). The Coinegraed VAR Model: Mehodology and Applicaions, Advanced Texs in Economerics, Oxford Universiy Press, Oxford. Kliber, A., P. Kliber, P. Płuciennik, (2012). Zależności pomiędzy sopami procenowymi rynku międzybankowego w Polsce, Przegląd Saysyczny,. LIX, nr 2. Kwiakowski, D., Phillips, P. Schmid, P., Shin, Y. (1992). "Tesing he null hypohesis of saionariy agains he alernaive of a uni roo: How sure are we ha economic ime series have a uni roo?", Journal of Economerics,. 54(1-3), sr , Moon, H. R., B. Perron, (2007). An empirical analysis of nonsaionariy in a panel of ineres raes wih facors, Journal of Applied Economerics,. 22(2), sr NBP, (2009). Rapor na ema pełnego uczesnicwa Rzeczypospoliej Polskiej w rzecim eapie UGW, NBP, Warszawa. Reade, J., U. Volz. (2010). Too Much To Lose, Or More To Gain? Should Sweden Join he Euro?, Universiy of Birmingham Discussion Papers nr Reade, J., U. Volz, (2011). "Leader of he pack? German moneary dominance in Europe prior o EMU," Economic Modelling, Elsevier,. 28(1-2), sr
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