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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)

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.

Suggested Citation

  • Jens Weidmann, 1997. "New Hope for the Fisher Effect? A Re-Examination Using Threshold Cointegration," Macroeconomics 9705005, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpma:9705005
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    References listed on IDEAS

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    Cited by:

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    3. Khalid Kisswani & Salah Nusair, 2014. "Nonlinear convergence in Asian interest and inflation rates: evidence from Asian countries," Economic Change and Restructuring, Springer, vol. 47(3), pages 155-186, August.
    4. Peter Kehinde, Mogaji, 2010. "Fisher Effect and the Relationship between Nominal Interest Rates and Inflation: The Case of Nigeria," MPRA Paper 98760, University Library of Munich, Germany.
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    6. Friesendorf, Cordelia & Durai, S. Raja Sethu, 2021. "Fisher Effect in Post-Unification Germany - Insights for Firms, Central Banks and Governments," Research Journal for Applied Management (RJAM), International School of Management (ISM), Dortmund, vol. 2(1), pages 53-67.

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    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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