The relationship between national real interest rates provides a valuable insight into the extent of economic and financial integration between countries. This paper tests for long‐run parity in ex post real interest rates among the major European Union (EU) countries over the period 1979–2003. The empirical investigation, however, is based on an alternative approach. Strong parity is determined by whether or not the first largest principal component (LPC), based on real interest rate differentials with respect to a chosen base country, is stationary. The qualitative outcome of the test is invariant to the choice of base country, and compared with alternative multivariate tests for long‐run parity, this methodology places less demands on limited data sets. Strong evidence of onshore parity occurs during 1979–1990 and 1993–2003 with the half‐life of a deviation to parity that varies towards 6 months. There is no evidence of long‐run parity among EU members during 1990–1993 despite the easing of remaining capital controls in 1990. Parity is rejected for a sample of non‐EU countries throughout the study period.
Tests for long‐run macroeconomic convergence among European Union (EU) countries according to the various exchange rate regimes that have prevailed over the last 40 years. Applying a recently developed test to the monthly index of industrial production data, output convergence is confirmed or rejected depending on whether or not the first largest principal component based on benchmark deviations with respect to Germany is stationary or not. It is argued that this methodology has key advantages over existing cointegrating and common trends procedures. For most EU countries, there is evidence of increased macroeconomic convergence during the 1990s, where evidence is particularly strong for Belgium, France and The Netherlands. The evidence also indicates that the Snake era of the 1970s was more conducive towards convergence than the initial exchange rate mechanism period of 1979‐1992. Firm evidence of convergence is lacking for Austria, Finland and Sweden, who joined the EU in 1995, and for a sample of non‐EU countries.