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The long-run Fisher effect: can it be tested?

  • Mark J. Jensen

Empirical support for the long-run Fisher effect, a hypothesis that a permanent change in inflation leads to an equal change in the nominal interest rate, has been hard to come by. This paper provides a plausible explanation of why past studies have been unable to find support for the long-run Fisher effect. This paper argues that the necessary permanent change to the inflation rate following a monetary shock has not occurred in the industrialized countries of Australia, Austria, Belgium, Canada, Denmark, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, Norway, Sweden, Switzerland, the United Kingdom, and the United States. Instead, this paper shows that inflation in these countries follows a mean-reverting, fractionally integrated, long-memory process, not the nonstationary inflation process that is integrated of order one or larger found in previous studies of the Fisher effect. Applying a bivariate maximum likelihood estimator to a fractionally integrated model of inflation and the nominal interest rate, the inflation rate in all seventeen countries is found to be a highly persistent, fractionally integrated process with a positive differencing parameter significantly less than one. Hence, in the long run, inflation in these countries will be unaffected by a monetary shock, and a test of the long-run Fisher effect will be invalid and uninformative as to the truthfulness of the long-run Fisher effect hypothesis.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta Working Paper No. with number 2006-11.

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Date of creation: 2006
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Handle: RePEc:fip:fedawp:2006-11
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  1. Jensen, Mark J. & Liu, Ming, 2006. "Do long swings in the business cycle lead to strong persistence in output?," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 597-611, April.
  2. Rose, Andrew Kenan, 1988. " Is the Real Interest Rate Stable?," Journal of Finance, American Finance Association, vol. 43(5), pages 1095-1112, December.
  3. Martin D.D. Evans & Karen K. Lewis, 1993. "Do Expected Shifts in Inflation Affect Estimates of the Long-Run Fisher Relation?," Working Papers 93-06, New York University, Leonard N. Stern School of Business, Department of Economics.
  4. Koustas, Z., Serletis, A., 1998. "On the Fisher Effect," Papers 98-09, Calgary - Department of Economics.
  5. Sowell, Fallaw, 1990. "The Fractional Unit Root Distribution," Econometrica, Econometric Society, vol. 58(2), pages 495-505, March.
  6. Bae, Sang-Kun & Jensen, Mark J. & Murdock, Scott G., 2005. "Long-run neutrality in a fractionally integrated model," Journal of Macroeconomics, Elsevier, vol. 27(2), pages 257-274, June.
  7. Robert G. King & Mark W. Watson, 1992. "Testing long run neutrality," Working Paper Series, Macroeconomic Issues 92-18, Federal Reserve Bank of Chicago.
  8. Huizinga, John & Mishkin, Frederic S., 1986. "Monetary policy regime shifts and the unusual behavior of real interest rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 24(1), pages 231-274, January.
  9. Sargent, Thomas J, 1971. "A Note on the 'Accelerationist' Controversy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 3(3), pages 721-25, August.
  10. Marcus J. Chambers, . "Long Memory and Aggregation in Macroeconomic Time Series," Economics Discussion Papers 437, University of Essex, Department of Economics.
  11. Fisher, Mark E & Seater, John J, 1993. "Long-Run Neutrality and Superneutrality in an ARIMA Framework," American Economic Review, American Economic Association, vol. 83(3), pages 402-15, June.
  12. Diebold, Francis X. & Inoue, Atsushi, 2001. "Long memory and regime switching," Journal of Econometrics, Elsevier, vol. 105(1), pages 131-159, November.
  13. 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.).
  14. Weber, Axel A, 1994. "Testing Long-run Neutrality: Empirical Evidence for G7 Countries with Special Emphasis on Germany," CEPR Discussion Papers 1042, C.E.P.R. Discussion Papers.
  15. Souza, Leonardo Rocha, 2003. "A note on Chambers's "long memory and aggregation in macroeconomic time series"," Economics Working Papers (Ensaios Economicos da EPGE) 503, FGV/EPGE Escola Brasileira de Economia e Finan├žas, Getulio Vargas Foundation (Brazil).
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