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Do Expected Shifts in Inflation Affect Estimates of the Long‐Run Fisher Relation?
Author(s) -
EVANS MARTIN D. D.,
LEWIS KAREN K.
Publication year - 1995
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1995.tb05172.x
Subject(s) - fisher hypothesis , inflation (cosmology) , odds , nominal interest rate , economics , econometrics , international fisher effect , real interest rate , markov chain , interest rate , monetary economics , statistics , mathematics , logistic regression , physics , theoretical physics
Recent empirical studies suggest that nominal interest rates and expected inflation do not move together one‐for‐one in the long run, a finding at odds with many theoretical models. This article shows that these results can be deceptive when the process followed by inflation shifts infrequently. We characterize the shifts in inflation by a Markov switching model. Based upon this model's forecasts, we reexamine the long‐run relationship between nominal interest rates and inflation. Interestingly, we are unable to reject the hypothesis that in the long run nominal interest rates reflect expected inflation one‐for‐one.