The Fisher Equation: A Nonlinear Panel Data Approach

ABSTRACT

This article reinvestigates the Fisher equation. Using the panel smooth transition regression (PSTR) model, it was found that there is a significant regime-switching effect concerning the impact of inflation on interest rates. Specifically, inflation is found to raise the interest rates and the effect becomes stronger in magnitude with inflation. However, the data do not provide evidence in support of the one-for-one Fisher effect. The evidence is robust to interest rates with different maturities and subsamples.

KEY WORDS:

• Fisher effects
• panel smooth transition regression

JEL CLASSIFICATION:

• C23
• E43

Funding

Yu-Bo Suen gratefully acknowledges the financial support of Taiwan’s National Science Council through grant NSC102-2410-H-156-004.

Notes

^1. Note that the PSTR model can be generalized to r + 1 extreme regimes as follows:

$R_{it}={\alpha }_i+{\beta }_0{\pi }_{it}+\sum _{j=1}^r{\beta }_j{\pi }_{it}\times g(q_{it};{\gamma }_j,c_j)+{\epsilon }_{it}.$

^2. Testing for no remaining nonlinearity consists of checking whether there is one transition function ($H_0:r=1$) or whether there are at least two transition functions ($H_1:r=2$). For more details, see Fouquau, Hurlin, and Rabaud (2008).

^3. Data on income and income growth are sourced from WDI; inflation targeting from de Mendonca and de Guimaraese Souza (2012); and exchange rate regimes from Rogoff and Reinhart (2004).

Additional information

Funding

Yu-Bo Suen gratefully acknowledges the financial support of Taiwan’s National Science Council through grant NSC102-2410-H-156-004.