The Fisher Effect Using Differences in The Deterministic Term

Abstract

The Fisher effect posits that nominal interest rates move one for one with inflation. This hypothesis has become an important concept in Financial Economics and has become the mainstay of inflation and interest rate targeting. Previous studies used cointegration tests particularly the Johansen cointegration test and the Johansen and Juselius cointegration methods to determine long run affiliations between nominal interest rates and inflation. The glitch is: the recent cointegration methodology proposed by Saikkonen and Ltkepohl has not been applied in the investigation of cointegrating vectors between nominal interest rates and inflation. Following Saikkonen & Ltkepohl, this study estimates deterministic terms of the time series under investigation and then proceeds with the cointegration process. The study tests for the Fisher effect for 20 selected countries and examines interest rates and inflation figures for the period 1982 to 2013 as provided by the World Bank and the International Monetary Fund (IMF). Conformingly, the results of the Saikkonen & Ltkepohl cointegration test show that the Fisher effect holds in all countries under examination. Comparatively, the Johansen cointegration procedure evidenced that the Fisher effect holds in all economies except the US, Bhutan, South Africa, Chile, Switzerland and Australia.