Research Paper No. 720

Changes in Regime and the Long Run Fisher Effect: A Threshold Cointegration Analysis

by

Olan T. Henry

NOVEMBER 1999

Department of Economics. University of Melbourne. Parkville Victoria 3052 Australia
 
 

ABSTRACT

The Fisher equation predicts that nominal interest rates and inflation should move together one-for-one. Recently published work argues that both nominal interest rates and inflation are non-linear. The evidence in this paper suggests that nominal interest rates are well described as two-regime threshold unit root processes. However, inflation and real interest rates appear to be stationary threshold processes. This is consistent with a threshold processes. This is consistent with a threshold cointegrating relationship between nominal interest rates and inflation. The long run Fisher equation describes the relationship between real interest rate inflation in periods of high inflation. In the low inflation regime shocks to real interest rates are highly persistent.
 
 

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