Mark J Jensen and Scott G. Murdock, Economics
Abstract. In this paper we model inflation and the nominal interest rate as a fractionally integrated, autoregressive, moving average (ARFIMA) process in order to test the theoretical proposition that nominal interest rates move one for one with inflation, thus, leaving the real interest rates unchanged; i.e. the Fisher effect. Using the necessary integration conditions first derived by Fisher and Seater (1993) and extended to fractional orders by Jensen et al. (forthcoming), we test the Fisher effect hypothesis in eleven developed countries; Belgium, Canada, Denmark, France, Germany, Greece, Ireland, Japan, the Netherlands, the UK, and the US. For each country, we first estimate and test the order of integration of inflation and the nominal interest rate with a univariate ARFIMA model. In seven of the eleven countries, the estimated relative order of integration between the inflation and interest rate series directly rules out a Fisherian link between inflation and nominal interest rates. One country’s order of integration fails to identify the Fisher effect and hence the hypothesis cannot be tested (Ireland). Because of the estimated orders of integration, testing for the Fisher effect in the three remaining countries (Belgium, Greece, and the US) requires the novel approach of applying the identification scheme of King and Watson (1997) to the fractionally differenced series. As in previous studies, we find little support for the Fisher effect.