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A re-evaluation of empirical tests of the Fisher hypothesis

  • Basma Bekdache

    ()

    (Wayne State University)

  • Christopher F. Baum

    ()

    (Boston College
    DIW Berlin)

This paper shows that the recent literature that tests for a long-run Fisher relationship using cointegration analysis is seriously flawed. Cointegration analysis assumes that the variables in question are I(1) or I(d) with the same d. Using monthly post-war U.S. data from 1959-1997, we show that this is not the case for nominal interest rates and inflation. While we cannot reject the hypothesis that nominal interest rates have a unit root, we find that inflation is a long-memory process. A direct test for the equality of the fractional differencing parameter for both series decisively rejects the hypothesis that the series share the same order of integration.

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Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 472.

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Length: 24 pages
Date of creation: 18 Sep 2000
Date of revision:
Handle: RePEc:boc:bocoec:472
Note: This paper was previously titled "The Fisher Equation in the Context of Fractional Cointegration"
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  1. Christopher F. Baum & John Barkoulas & Mustafa Caglayan, 1996. "Persistence in International Inflation Rates," Boston College Working Papers in Economics 333., Boston College Department of Economics.
  2. Peter C.B. Phillips, 1998. "Econometric Analysis of Fisher's Equation," Cowles Foundation Discussion Papers 1180, Cowles Foundation for Research in Economics, Yale University.
  3. Kwiatkowski, Denis & Phillips, Peter C. B. & Schmidt, Peter & Shin, Yongcheol, 1992. "Testing the null hypothesis of stationarity against the alternative of a unit root : How sure are we that economic time series have a unit root?," Journal of Econometrics, Elsevier, vol. 54(1-3), pages 159-178.
  4. Baillie, Richard T & Chung, Ching-Fan & Tieslau, Margie A, 1996. "Analysing Inflation by the Fractionally Integrated ARFIMA-GARCH Model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(1), pages 23-40, Jan.-Feb..
  5. Perron, P., 1994. "Further Evidence on Breaking Trend Functions in Macroeconomic Variables," Cahiers de recherche 9421, Universite de Montreal, Departement de sciences economiques.
  6. Perron, Pierre & Vogelsang, Timothy J, 1992. "Nonstationarity and Level Shifts with an Application to Purchasing Power Parity," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(3), pages 301-20, July.
  7. Sowell, Fallaw, 1990. "The Fractional Unit Root Distribution," Econometrica, Econometric Society, vol. 58(2), pages 495-505, March.
  8. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  9. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, vol. 65(3), pages 269-82, June.
  10. Hassler, Uwe & Wolters, Jurgen, 1994. "On the power of unit root tests against fractional alternatives," Economics Letters, Elsevier, vol. 45(1), pages 1-5, May.
  11. Hassler, Uwe & Wolters, Jurgen, 1995. "Long Memory in Inflation Rates: International Evidence," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(1), pages 37-45, January.
  12. Cochrane, John H., 1991. "A critique of the application of unit root tests," Journal of Economic Dynamics and Control, Elsevier, vol. 15(2), pages 275-284, April.
  13. Perron, P., 1989. "Testing For A Unit Root In A Time Series With A Changing Mean," Papers 347, Princeton, Department of Economics - Econometric Research Program.
  14. Phillips, Peter C.B., 2007. "Unit root log periodogram regression," Journal of Econometrics, Elsevier, vol. 138(1), pages 104-124, May.
  15. Wu, Yangru & Zhang, Hua, 1996. "Mean Reversion in Interest Rates: New Evidence from a Panel of OECD Countries," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 604-21, November.
  16. Crowder, William J & Hoffman, Dennis L, 1996. "The Long-Run Relationship between Nominal Interest Rates and Inflation: The Fisher Equation Revisited," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(1), pages 102-18, February.
  17. Chang Sik Kim & Peter C.B. Phillips, 2006. "Log Periodogram Regression: The Nonstationary Case," Cowles Foundation Discussion Papers 1587, Cowles Foundation for Research in Economics, Yale University.
  18. Evans, Martin D D & Lewis, Karen K, 1995. " Do Expected Shifts in Inflation Affect Estimates of the Long-Run Fisher Relation?," Journal of Finance, American Finance Association, vol. 50(1), pages 225-53, March.
  19. Peter C.B. Phillips, 1999. "Discrete Fourier Transforms of Fractional Processes," Cowles Foundation Discussion Papers 1243, Cowles Foundation for Research in Economics, Yale University.
  20. Gonzalo, J. & Lee, T.H., 1995. "Pitfalls in Testing for Long Run Relationships," Papers 38, Boston University - Department of Economics.
  21. Michael Dueker & Richard Startz, 1998. "Maximum-Likelihood Estimation Of Fractional Cointegration With An Application To U.S. And Canadian Bond Rates," The Review of Economics and Statistics, MIT Press, vol. 80(3), pages 420-426, August.
  22. Francis X. Diebold & Glenn D. Rudebusch, 1990. "On the power of Dickey-Fuller tests against fractional alternatives," Finance and Economics Discussion Series 119, Board of Governors of the Federal Reserve System (U.S.).
  23. Ng, S. & Perron, P., 1994. "Unit Root Tests ARMA Models with Data Dependent Methods for the Selection of the Truncation Lag," Cahiers de recherche 9423, Centre interuniversitaire de recherche en ├ęconomie quantitative, CIREQ.
  24. Graham Elliott & Thomas J. Rothenberg & James H. Stock, 1992. "Efficient Tests for an Autoregressive Unit Root," NBER Technical Working Papers 0130, National Bureau of Economic Research, Inc.
  25. Mishkin, Frederic S., 1992. "Is the Fisher effect for real? : A reexamination of the relationship between inflation and interest rates," Journal of Monetary Economics, Elsevier, vol. 30(2), pages 195-215, November.
  26. Crato, Nuno & Rothman, Philip, 1994. "Fractional integration analysis of long-run behavior for US macroeconomic time series," Economics Letters, Elsevier, vol. 45(3), pages 287-291.
  27. 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.
  28. Hauser, Michael A & Kunst, Robert M, 1998. " Fractionally Integrated Models with ARCH Errors: With an Application to the Swiss One-Month Euromarket Interest Rate," Review of Quantitative Finance and Accounting, Springer, vol. 10(1), pages 95-113, January.
  29. Christopher F. Baum & Vince Wiggins, 2001. "Tests for long memory in a time series," Stata Technical Bulletin, StataCorp LP, vol. 10(57).
  30. Clemente, Jesus & Montanes, Antonio & Reyes, Marcelo, 1998. "Testing for a unit root in variables with a double change in the mean," Economics Letters, Elsevier, vol. 59(2), pages 175-182, May.
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