Correct Cointegration Tests of the Long Run Relationship Between Nominal Interest and Inflation
The Fisher (1930) hypothesis suggests that a long run equilibrium relationship exists between the nonstationary series: nominal interest and expected inflation. Testing such a cointegrating relationship is complicated by the presence of the unobserved ex ante real rate of interest in residuals from the cointegrating regression. Assumptions concerning the stochastic properties of the expected real rate of interest are examined and two proxies for the ex ante real rate are employed in multivariate cointegration tests of the Fisher hypothesis.
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