Fisher Effect and the Relationship between Nominal Interest Rates and Inflation: The Case of Nigeria

Mogaji, Peter Kehinde (2010): Fisher Effect and the Relationship between Nominal Interest Rates and Inflation: The Case of Nigeria.

Abstract

This research study carries out empirical investigations of the Fisher effect and the long-run relationship between nominal interest rates and expected inflation in Nigeria making use of annual data covering a period of half of a century. Fisher (1930) postulation is that nominal interest rates should reflect the expected rate inflation rates movements on one-for-one basis. Applying the Nigerian data covering the period between 1961 and 2009, this study uses the 3-month treasury bill rates to proxy for nominal interest rates while the 12-month moving average headline inflation serves as the expected inflation. Apart from the descriptive analyses of the sample data, the econometric approaches which the study employs are the ordinary least square (OLS) regression, the Engle-Granger ADF residual-based cointegration, the Johansen maximal likelihood cointegration and Granger causality test. Testing the data, using the augmented Dickey-Fuller (ADF) unit root test method, it was found out that nominal interest rate and expected inflation were non-stationary in levels but in first differences. This suggests that the OLS regression may be spurious even as the result rejects a full fisher effect in Nigeria. The results of the cointegration tests imply that there is no long-run cointegration relationship between nominal interest rates and inflation in Nigeria. The Granger causality tests report that expected inflation does not Granger cause nominal interest rates in Nigeria, but a one-way directional movement running only from nominal interest rates to inflation. The problem of high inflation identified in the history of Nigeria prompted the recommendation for the adoption inflation targeting policy for the country and other countries in this category while the interest rate should be set in line with the dictates of the economy.

• Item Type: MPRA Paper
• Language: English
• Keywords: Fisher Effect
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects

References

Bajo-Rubio, O., Diaz-Roldan, C., and Esteve, V. (2005), ‘Is the Fisher Effect Non-linear? Some evidence from Spain, 1963 – 2002, Applied Financial Economics, Vol. 15, pp. 849 – 854.

Bajo-Rubio, O., Diaz-Roldan, C., and Esteve, V. (2010), Testing the Fisher Effect in the Presence of Structural Change: A Case Study of the UK, 1966 – 2007, Economic Issue, Vol. 16, Part 2.

Barsky, R. B. and Summers, L. H. (1988), ‘Gibson’s Paradox and the Gold Standard’, Journal of Political Economy, Vol. 96 (3), pp. 528 – 550.

Begg, D, Fischer, S. and Dornbusch, R. (2008), ‘Economics’ 9th Edition, Maidenhead: McGraw-Hill Education (UK) Limited.

Berument, H. and Jelassi, M.M. (2002), ‘Fisher Hypothesis: A Multi-country Analysis, Applies Economics Vol. 34, pp.1645-1655.

Bose, N. (2002), ‘Inflation, the Credit Market and Economic Growth’, Oxford Economic Papers, 54(3), pp 412 -434

Boudoukh, J. and Richardson M. (1993), ‘Stock Returns and Inflation: A long-horizon Perspective’, American Economic Review, Vol. 83, pp. 1348 – 55.

Cargill, T.F. (1977), ‘Direct Evidence of the Darby Hypothesis for the United States’, Economic Inquiry, Vol.15, pp.132-134

Carlson J.A. (1977), ‘Short term Interest Rates as Predictors of Inflation: Comment’, American Economic Review, 67(3), pp. 469-475.

Carmichael J., and Stebbing, P.W.(1983), ‘Fisher’s Paradox and Theory of Interest’, American Economic Review, Vol. 73, pp. 619 – 630.

Carr, J., Pesando J. E. and Smith, L.B. (1976), ‘Tax Effects, Price Expectations and the Nominal Rate of Interest’, Economic Inquiry Vol.15, pp. 132-134.

Central Bank of Nigeria (2008), ‘Statistical Bulletin’ Golden Jubilee Edition, Abuja: Central Bank of Nigeria.

Central Bank of Nigeria (2009), ‘Statistical Bulletin’, Abuja: Central Bank of Nigeria.

Central Bank of Nigeria (2010), ‘Economic Report for the First Half of 2010’, Abuja: Central Bank of Nigeria.

Cooray, A. (2003), ‘The Fisher Effect: A Survey’, The Singapore Economic Review, Vol. 48(2), pp.135-150.

Choudhry, A. (1997),’Cointegration Analysis of the Inverted Fisher Effect: Evidence from Belgium, France and Germany’. Applied Economics Letters, Vol. 4, pp 257 – 260

Crowder, W.J. and Hoffman D.L (1996), ‘The Long Run Relationship between Nominal Interest Rates and Inflation: The Fisher Equation Revisited’, Journal of Money, Credit and Banking, Vol. 28(1), pp.102 -118.

Crowder, W.J. and Wohar, M. E. (1999), ‘Are Tax Effects Important in the Long-run Fisher Relationship? Evidence from the Municipal Bond Market’, Journal of Finance, Vol. 54 (1), pp. 307 – 317.

Darby, M.R. (1975). ‘The Financial and Tax Effect of Monetary Policy on Interest Rate’, Economic Inquiry, Vol. 13(2), pp. 226-276.

Dickey, D.A. and Fuller, W.A. (1981), ‘Likelihood Ratio Statistics foe Autoregressive Time Series with Unit Root, Econometrica, Vol. 49, pp. 1057 – 1072.

Dutt, S. and Ghosh D. (2007 ), ‘A Threshold Cointegration Test of the Fisher Hypothesis Case Study of 5 European Nations’. Southwestern Economic Review, Vol. 34(1), pp.41 -45.

Engle, R.F. and Granger, C.W. (1987), ‘Cointegration and Error Correction: Representation, Estimation and Testing, Econometrica, Vol. 5, pp. 251 – 276.

Engstead, T. (1996), ‘Non-Stationarity and Tax Effects in the Long-term Fisher Hypothesis’, Applied Economics, Vol.28, pp. 883-887.

Evans, M.D. (1998), ‘Real Rates, Expected Inflation and Inflation Risk Premia” Journal of Finance, Vol. 53(1) pp. 87-218.

Fama E.F. (1975), ‘Short Term Interest Rates as Predictors of Inflation, American Economic Review, Vol. 65, pp. 269-282.

Feldstein, M. (1976),’Inflation, Income Tax and the Rate of Interest: A Theoretical Analysis’, American Economic Review, Vol. 66, pp. 809-820.

Fisher, I. (1896), ‘Appreciation and Interest’, AEA Publications, Vol. 3(11), pp. 341 – 442.

Fisher, I. (1930), ‘The Theory of Interest’, New York: Macmillan.

Friedman, M. (1953), ‘Essay on Methodology of Positive Economics’, London: The University of Chicago Press Limited.

Gandolfi, A.E. (1982), ‘Inflation Taxation and Interest Rates’, Journal of Finance, Vol. 37, pp. 797-807.

Gibson, W. E. (1970),’Price Expectations Effects on Interest Rates’, Journal of Finance, Vol. 25, pp. 19 – 34.

Graham, F.C. (1988), ‘The Fisher Hypothesis: A Critique of Recent Results and Some New Evidence’, Southern Economic Journal, Vol. 54, pp. 961 – 968.

Granger, C.W.J. (1969), ‘Investigating Causal Relations by Econometric Models and Cross-Spectral methods’, Econometrica’, Vol. 37, pp. 424 – 438.

Granger, C.W.J. (1986), ‘Developments in the Study of Cointegrated Economic Variables, Oxford Bulletin of Economics and Statistics 48, Vol. 3.

Granger, C. W. J. and Newbold, P. (1974), ‘Spurious Regression in Econometrics, Journal of Econometrics, Vol. 2, pp. 111 – 120.

Granville, B. and Mallick, S. (2004), ‘Fisher hypothesis: Evidence Over a Century’, Applied Economics Letter 11, pp. 87-90.

Gul, E. and Ekinci, A. (2006), ‘The Causal Relationship Between Nominal Interest Rates and Inflation: The Case of Turkey’, Scientific Journal of Administrative Development, Volume 4.

Hawtrey, K.M. (1997), ‘The Fisher Effect and Australian Interest Rates’, Applied Financial Economics, Vol. 7(4) pp. 337 - 346.

Hess, P.J. and Bicksler, J. L. (1975), ‘Capital Asset Prices Versus Time Series Models as Predictors of Inflation: The Expected Real Rate of Interest and Market Efficiency’, Journal of Financial Economics, Vol. 2, pp. 341 – 360.

Hausman, D. M. (1992), ‘Essays on Philosophy and Economic Methodology’. Cambridge: Cambridge Press.

Jansen, M.J. (2006), ‘The Long Run Fisher Effect: Can it be Tested? The Federal Reserve Bank of Atlanta Working Paper No. 2006-11

Johansen, S (1988), ‘Statistical Analysis of Cointegration Vectors’, Journal of Economic Dynamics and Control, Vol. 12, pp. 231-254.

Johansen, S. and Juselius K. (1990), ‘Maximum Likelihood Estimation and Inference on Cointegration - With Applications to the Demand for Money’, Oxford Bulletin of Economics and Statistics Vol. 52(3) pp.169-210.

Joines, D. (1977), ‘Short term Interest Rates as Predictors of Inflation: Comment’ American Economic Review, Vol. 67(3), pp. 476 – 477.

Jorgensen, J. J. and Terra, P. R. S. (2003), ‘The Fisher Hypothesis in a VAR Framework: Evidence from Advanced and Emerging Markets’, Conference Paper at European Financial Management Association Annual Meeting, Helsinki, 25-28 June

Juntilla, J. (2001), ‘Testing an Augmented Fisher Hypothesis for Small Open Economy: The Case of Finland’, Journal of Macroeconomics, Vol. 23(4), pp. 577 – 599.

Kandil, M. (2005), ‘Money, Interest and Price: Some International Evidence’, International Review of Economics and Finance, 14, pp 129 – 147.

Kasimir, K. (2007), ‘The Fisher Effect, Surrey Data and Time-Varying Volatility’, Journal of Empirical Economic, Vol 35 No 1 cited at http:/www.springerlink.com/content/m774197123147m Do fulltext.Ddf? Page=1(Accessed on June 10, 2009)

Keynes, J. M. (1930), ‘A Treatise on Money’, London: Macmillan.

Keynes, J. M. (1936), ‘The General Theory of Employment, Interest and Money, London: Macmillan.

Lahiri, K. (1976), ‘On the Constancy of Real Interest Rates, Economic Letters, Vol. 1 (3), pp.45 - 48.

Lipsey R and Chrystal K (2007) ‘Economics’, Oxford: Oxford University Press.

MacDonald R. and Murphy, P.D. (1989), “Testing for the Long Run Relationship between Nominal Interest Rates and Inflation Using Cointegration Techniques, Applied Economics, Vol. 21, pp. 439-447.

Mitchell-Innes, H.A (2006) The Relationship between Interest Rates and Inflation in South Africa: Revisiting Fisher’s Hypothesis, Unpublished Thesis Submitted to Rhodes University.

Mills, J.S. (1843), ‘Principles of Political Economy: Printed in Collected Works on John Stuart Mill’, Vol 4 – J. Robson Edition, 1961. Toronto: University of Toronto Press.

Mishkin, F.S. (1992), ‘Is the Fisher Effect for Real? - A Re-examination of the Relationship between Inflation and Interest Rates’, Journal of Monetary Economics, Vol. 30(2), pp. 195 – 215.

Mishkin, F. (1984), ‘The Real Interest Rates: A Multi-country Empirical Study’, Canadian Journal of Economics, Vol. 17, pp. 226-311.

Mishkin , F .S. and Simon J. (1995), ‘An Empirical Examination of the Fisher Effect in Australia’, Economic Record Vol. 71, pp. 217-229.

Moazzami, B. (1991), ‘The Fisher Equation Controversy Re-examined’, Applied Financial Economics, Vol.1, pp.129 – 133.

Moser, G.G.C. (1995), ‘The Main Determinants of Inflation in Nigeria’, IMF Staff Papers, Vol. 42(2).

Mundell, R. (1963), ‘Inflation and Real Interest’, Journal of Political Economy, Vol. 71, pp 280-283.

Nelson, C.R. and Plosser, C.R. (1982), ‘Trends and Random Walks in Macroeconomic Time Series: Some Evidence and Implications’, Journal of Monetary Economics, Vol. 10(2), pp. 139 – 162.

Nelson, C and Schwert, G.W (1977), ‘Short-Term Interest rates as Predictors of Inflation: On Testing the Hypothesis that the Real Rate of Interest is Constant’, American Economic Review, Vol. 67(3), pp. 478-786.

Nielson, N.C. (1981), ‘Inflation and Taxation: Nominal and Real Rates of Return’ Journal of Monetary Economics, Vol. 7, pp. 261-270.

Obi, O., Nurudeen A. and Wafure O.G. (2009), ‘An Empirical Investigation of the Fisher Effect in Nigeria: A Cointegration and Error Correction Model Approach’, International Review of Business, Vol. 5(5), pp. 96 – 109.

Parking M (1998), ‘Inflation’ in Eatwell, J. Milgate, M. and Newman, P (eds) The new Palgrave Dictionary of Economics, New York: Palgrave Publishers Ltd.

Payne, J.E. and Ewing, B.T. (1997), ‘Evidence from Lesser Developed Countries on the Fisher hypothesis: A Cointegration Analysis’, Applied Economic Letters, Vol. 4 pp. 683-687.

Peek, J, (1982), ‘Interest Rates, Income Taxes and Anticipated Inflation’, American Economic Review, Vol. 72(5), pp. 980-91.

Phylakitis, K. and Blake, D. (1993), ‘The Fisher Hypothesis Evidence from Three High Inflation Economies;, Weltwirlschaftliches Archiv Vol.129, pp. 2591599

Rose A. K. (1988), ‘Is the Real Rate Stable’, Journal of Finance, Vol. 43(5), pp. 1095 - 1112.

Sargent, T.J. (1969), ‘Commodity Price Expectations and Interest Rate’ in Gibson, W.E. and Kaufman, G.G. (eds.) Monetary Economics: Readings on Current Issues, New York: McGraw Hill Book Co.

Shome, D.K., Smith, S.D. and Pinkerton, J.M. (1988), ‘The Purchasing Power of Money and Nominal Interest Rates: A Re-examination’. Journal of Finance, Vol. 43, pp. 1113 – 25.

Sorense B.E. (2005), ‘Granger Causality’, Economics 7395, Spring 2005.

Sun, Y. and Phillip, P.C.B. (2004) ‘Understanding the Fisher Equation’, Journal of Applied Econometrics, Vol.19 (7) pp. 869-886.

Tanzi, V. (1980), ‘Inflationary Expectations, Economic Activity, Taxes and Interest Rates’, American Economic Review, Vol. 70(1), pp.12-21.

Thornton, J. (1996), ‘The adjustment of Nominal Interest Rates in Mexico: A Study of the Fisher Effect’, Applied Economics Letter Vol. 3 pp. 225-257.

Tillmann, P (2004), ‘Testing For Stationarity and Pre- Specified Cointegration under Regime-Switching: A Note on the Fisher Effect’ Institute of International Economics, University of Bonn Working Paper.

Tobin, J. (1965), ‘Money & Economic Growth’, Econometrica, Vol. 33, pp. 671 – 684

Tsong, C. and Lee, C. (2009), ‘The Fisher Hypothesis: A Revisit with Covariate Tests, Conference Paper Presented at 10th Annual Conference on Empirical Economics, in Chiay, Taiwan.

Weidmann, J. (1997), ‘New Hope for the Fisher Effect?: A Reexamination Using Threshold Cointegration, University of Bonn Discussion Paper B – 385.

Wesso, G.R. (2000), ‘Long-term Yield Bonds and Future Inflation in South Africa: A Vector Error-Correction Analysis’, Quarterly Bulletin, Pretoria South Africa Reserve Bank, June.

Wijesinghe, T. (2002), ‘The Relationship between Nominal Interest Rates and Inflation in Sri Lanka’, Midwest Business Economic Association – 2002 Proceedings.

Woodward, G. T. (1992), ’Evidence of the Fishers Effect from UK Indexed Bonds’, Review of Economics and Statistics, Vol. 74, pp. 315 – 320.

Yohe, W.P. and Karnosky, D.S. (1969), ‘Interest Rates and Price Levels Changes’ in Gibson, W.E. and Kaufman, G.G. (eds.) Monetary Economics: Readings on Current Issues, New York: McGraw Hill Book Co.

Yuhn, K. H. (1996), ‘Is the Fisher Effect Robust? - Further Evidence’, Applied Economic Letters, Vol.3, pp. 41 – 4.