RDP 9506: The Liberalisation and Integration of Domestic Financial Markets in Western Pacific Economies Appendix 3: Speed of Adjustment

The error-correction model of the institutional interest rate is:

which is equation (14) in the text. In all cases apart from the Indonesian deposit rate and Taiwanese loan rate, lags of the dependent variable are not statistically significant. In the remaining cases, apart from the Australian loan rate from 1980M1 to 1984M12, the parsimonious regression includes at most only the error-correction term and the contemporaneous change in the money market rate. In the case of the Australian loan rate from 1980M1 to 1984M12, the first lag of the change in the money market rate is also statistically significant. Short-run dynamics are fast and speed up the adjustment to equilibrium as they eliminate the disequilibrium that exists between the money and institutional rate.

The parsimonious equation is:

where Inline Equation. Assuming that the series have been demeaned and that the money market rate rises by one percentage point, the cumulative adjustment after n-periods, n≥2 is:

Note that γ sums the adjustment that occurs in the contemporaneous and first period. When the dynamics terms are statistically insignificant, the error-correction alone drives the changes in the institutional rate and (A3–3) reduces to: