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Is it Really the Fisher Effect?

Fahmy and Kandil [2003] use a cointegration approach to test for the Fisher effect in US interest rates during the 1980s and early 1990s. Here, I argue that even if nominal interest rates and inflation rates do obey integrated processes, cointegration of these two processes is not a sufficient condition for the Fisher effect to hold as it is consistent with any theory implying a stationary real interest rate. As the Fisher effect ex post implies that nominal interest rates embody an optimal inflation forecast, the sufficient condition for it to hold is the unpredictability of the implied inflation forecast error. This condition may be tested using the signal extraction framework of Durlauf and Hall [1988, 1989].

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Paper provided by Vassar College Department of Economics in its series Vassar College Department of Economics Working Paper Series with number 58.

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Date of creation: Jan 2004
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Handle: RePEc:vas:papers:58
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  1. Carl Bonham, 1991. "Correct Cointegration Tests of the Long Run Relationship Between Nominal Interest and Inflation," Working Papers 199104, University of Hawaii at Manoa, Department of Economics.
  2. 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.
  3. 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.
  4. William J. Crowder, 1997. "The Long-Run Fisher Relation in Canada," Canadian Journal of Economics, Canadian Economics Association, vol. 30(4), pages 1124-42, November.
  5. Fahmy, Yasser A. F. & Kandil, Magda, 2003. "The Fisher effect: new evidence and implications," International Review of Economics & Finance, Elsevier, vol. 12(4), pages 451-465.
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