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New Hope for the Fisher Effect? A Re-Examination Using Threshold Cointegration

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  • Jens Weidmann

    (University of Bonn)

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    Abstract

    This paper reassesses the long-run relation between nominal interest rates and inflation using German data. It shows that the empirical rejection of the strict Fisher effect in previous studies, i.e., the finding of interest rates not fully adjusting to changes in inflation, can be attributed to the particular time series behavior of inflation and interest rates which cannot be accounted for by standard non- stationary models. It is argued that the stochastic process governing the bivariate system of inflation and interest rates depends on the level of the variables and should be modeled as a thresh-old cointegration (TC) model. Contrary to the unit root hypothesis this model can be given an economic interpretation in terms of the opportunistic approach to disinfla-tion. The full Fisher effect, even in its tax-adjusted form, cannot be rejected when a threshold cointegration model is estimated. The TC model not only explains the downward bias of the coefficient estimates, but also the sample and country sensitivity observed in previous studies. The TC model may prove useful in testing other long-run relations such as uncovered interest rate parity or purchasing power parity.

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    File URL: http://128.118.178.162/eps/mac/papers/9705/9705005.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series Macroeconomics with number 9705005.

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    Date of creation: 14 May 1997
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    Handle: RePEc:wpa:wuwpma:9705005

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    Web page: http://128.118.178.162

    Related research

    Keywords: Inflation; interest rates; unit-roots; cointegration; bootstrap; Monte Carlo; threshold cointegration; SETAR-models;

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    1. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
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    3. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    4. Robert B. Barsky, 1986. "The Fisher Hypothesis and the Forecastability and Persistence of Inflation," NBER Working Papers 1927, National Bureau of Economic Research, Inc.
    5. Nathan S. Balke & Thomas B. Fomby, 1992. "Threshold cointegration," Research Paper 9209, Federal Reserve Bank of Dallas.
      • Balke, Nathan S & Fomby, Thomas B, 1997. "Threshold Cointegration," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(3), pages 627-45, August.
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    16. Peter C.B. Phillips & Pierre Perron, 1986. "Testing for a Unit Root in Time Series Regression," Cowles Foundation Discussion Papers 795R, Cowles Foundation for Research in Economics, Yale University, revised Sep 1987.
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