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An Empirical Examination of the Fisher Hypothesis in

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  • Ramya Hewarathna

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    (School of Economics, La Trobe University)

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    Abstract

    Maintaining a low rate of inflation is very important to achieve sustainable economic growth but is a challenging task for policy makers. Interest rates are one of the main channels through which monetary policy changes can be used to achieve this goal of low inflation. Thus, a significant relationship between interest rates and inflation reveals the effectiveness of monetary policy in controlling inflation. The Fisher hypothesis provides a theoretical basis for this relationship. This hypothesis states the nominal interest rate rises one-for-one with inflationary expectations, maintaining, other things being constant, a constant real interest rate. The aim of this study is to test the Fisher hypothesis in Sri Lanka with the aid of recently introduced econometric tools for the period January 1986 to December 1995, using monthly data. Even though the current inflation rate in Sri Lanka is not as high as in most developing countries, maintaining a low inflation rate receives a high priority in the Sri Lankan Governments policy agenda. The results suggest that Sri Lankan nominal interest rates do not fully adjust to expected inflation which in turn indicates that real variables are not completely insulated from monetary changes. Therefore, changes in monetary instruments do not appear to be completely effective in meeting the goal of low inflation.

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    File URL: http://www.latrobe.edu.au/__data/assets/pdf_file/0007/130858/2000.03.pdf
    File Function: First version, 2000.03.pdf
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    Bibliographic Info

    Paper provided by School of Economics, La Trobe University in its series Working Papers with number 2000.03.

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    Length: 20 pages
    Date of creation: 2000
    Date of revision:
    Handle: RePEc:trb:wpaper:2000.03

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    Keywords: Macroeconomics; Inflation;

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    1. Mishkin, Frederic S & Simon, John, 1995. "An Empirical Examination of the Fisher Effect in Australia," The Economic Record, The Economic Society of Australia, vol. 71(214), pages 217-29, September.
    2. J. Joseph Beaulieu & Jeffrey A. Miron, 1992. "Seasonal Unit Roots in Aggregate U.S. Data," NBER Technical Working Papers 0126, National Bureau of Economic Research, Inc.
    3. Sargan, John Denis & Bhargava, Alok, 1983. "Testing Residuals from Least Squares Regression for Being Generated by the Gaussian Random Walk," Econometrica, Econometric Society, Econometric Society, vol. 51(1), pages 153-74, January.
    4. Gregory, Allan W. & Hansen, Bruce E., 1996. "Residual-based tests for cointegration in models with regime shifts," Journal of Econometrics, Elsevier, vol. 70(1), pages 99-126, January.
    5. Hyllerberg, S. & Engle, R.F. & Granger, C.W.J. & Yoo, B.S., 1988. "Seasonal Integration And Cointegration," Papers, Pennsylvania State - Department of Economics 0-88-2, Pennsylvania State - Department of Economics.
    6. Param Silvapulle & Brett Inder, 1992. "Does the Fisher Effect Apply in Australia?," Working Papers, School of Economics, La Trobe University 1991.02, School of Economics, La Trobe University.
    7. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, Econometric Society, vol. 55(2), pages 251-76, March.
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