A Long‐Run Non‐Linear Approach to the Fisher Effect

Abstract

We argue that the empirical failure of the Fisher effect found in the literature may be due to the existence of non‐linearities in the long‐run relationship between interest rates and inflation. We present evidence that, for the U.S. during the 1960–2004 period, the Fisher relation presents important non‐linearities. We model the long‐run non‐linear relationship and find that an ESTR model for the pre‐Volcker era and an LSTR model for the post‐Volcker era are able to control for non‐linearities and constitute long‐run co‐integration vectors. Monte Carlo evidence produces support for the hypothesis that non‐linearities may also be responsible for the less than proportional coefficients of inflation usually found in the linear specifications.

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