William J. Crowder

The Long Run Relationship between Nominal Interest Rates and Inflation: The Fisher Equation Revisited

The empirical literature examining the Fisher equation has produced results that are generally inconsistent with the simple textbook representation. Much of this evidence is obtained from statistical analysis that fails to recognize that the nominal interest rate and expected inflation may be modeled as distinct nonstationary series that share a common stochastic trend. Using a fully efficient estimator of the implied cointegration vector we find evidence of a postwar Fisher relation that is consistent with the standard textbook representation even when taxes on interest income are taken into account. Dynamic analysis based on this long-run relation identifies the common source of the instability (non-stationarity) in the system of nominal interest rates and inflation as the accumulation of inflation innovations. The dynamic response of the system to these shocks is examined by distinguishing the shock that leaves a permanent imprint on the system from the shock that has only a transitory effect. Copyright 1996 by Ohio State University Press.

Foreign exchange market efficiency and common stochastic trends

Abstract In a recent paper, Baillie and Bollerslev (1989), using daily data from 1980 to 1985, identified six common stochastic trends in a vector of seven nominal exchange rates implying the existence of one cointegrating vector. Cointegration implies that (Granger) causality must run in at least one direction, that is, at least one of the exchange rates is predictable using current available information. This result has been interpreted as foreign exchange market inefficiency, by many. Another interpretation is suggested if the stationary linear combination of spot rates proxies for a time varying risk premium in some way. Then these results could be explained in a rational and risk averse market. This possibility is eliminated if the time series properties of the risk premium are incompatible with those of the error correction term. Specifically, it is demonstrated that the forward risk premium is non-stationary for the exchange rates that comprise the exchange rate cointegration relationship. In this paper, the existence of common stochastic trends in a vector of nominal exchange rates is tested over the period 1974 to 1991. The efficiency of foreign exchange markets is then tested by examining the implications of stochastic trends in the forward premium and what this means for the time series properties of a time-varying forward risk premium. (JEL F31, G14).

Are Tax Effects Important in the Long-Run Fisher Relationship? Evidence from the Municipal Bond Market

Recent studies of the Fisher relation have yielded contradictory conclusions on the importance of taxes in determining the long-run response of nominal interest rates to changes in expected inflation. This study uses data on taxable U.S. treasury and tax exempt municipal bond interest rates to shed light on the effects of inflation on nominal interest rates.

The Long-Run Fisher Relation in Canada

In this paper, the existing Fisher equation research is extended to time series on the Canadian nominal interest rate and inflation to test the validity of the Fisher hypothesis and related hypotheses. The evidence suggests a significant long-run equilibrium between nominal rates and inflation in Canada but that this relationship has not been completely stable over the last three decades.

Balanced growth and public capital: an empirical analysis

The balanced growth restrictions implied by the neoclassical growth model imply that output, the private capital stock and the public capital stock share the same stochastic trend. We analyse the postwar US data on real output, real private capital stock and real public capital stock and find that the balanced growth restrictions cannot be rejected by the data. Removing the common stochastic trend from each series allows the estimation of output elasticities that is free from the spurious regression problem. The results support Aschauers (1989) claim that, at the margin, public capital is more productive than private capital.

Identification, Long-Run Relations, and Fundamental Innovations in a Simple Cointegrated System

This paper examines the roles played by innovations identified from a simple four-variable VAR characterized by cointegration. Using knowledge of cointegration rank and textbook relations that link macroeconomic aggregates, we identify distinct real and nominal innovations that dictate the long-run behavior of the model. We also examine the explanatory power of transitory innovations that are orthogonal to these permanent shocks. One of the permanent shocks displays all the characteristics of a technology or supply innovation, while one of the transitory innovationsidentified by imposing short-run price rigid-ityis interpretable as a demand side impulse. The permanent nominal shock bears the imprint of an innovation in aggregate inflation expectations. Historical decomposition and comparison with variables that are external to the model reveals the relative importance of the shocks at various episodes.

Why Are Real Interest Rates Not Equalized Internationally

In this study, we specify a set of sufficient parity conditions for real interest rates to be equalized internationally, what we call real interest parity (RIP). Using multivariate unit root tests, which have significantly greater power than univariate alternatives, we demonstrate that these sufficient conditions are not satisfied for five industrialized nations over the period of 1960–1996. We then examine each parity condition individually to shed some light on the source of the rejection of RIP. Our results suggest that no single violation can explain the failure of RIP in all cases. It does appear, however, that the Fisher relation is the least likely to violate the RIP equilibrium, whereas uncovered interest parity (UIP) appears to be the most commonly violated. This result is consistent with a nonstationary risk premium in the foreign exchange market.

Covered interest parity and international capital market efficiency

Abstract Tests of covered interest parity (CIP) are prevalent in the economics and finance literature. These studies demonstrate that there does exist some profitable deviations of exchange rates and interest rates from the equilibrium implied by CIP. Unfortunately, no conclusions regarding market efficiency can be drawn from such evidence since efficient markets do not preclude profitable deviations, only the persistence of such deviations. This study uses impulse response analysis on the CIP equilibrium of daily exchange rates and interest rates in order to analyze the persistence of arbitrage profits. The results suggest that risk free profits persist longer that can be reconciled with market efficiency. JEL Classifications: F31, F41, C32.

The international convergence of inflation rates during fixed and floating exchange rate regimes

Abstract According to the assets approach to the balance of payments/exchange rate, under a fixed exchange rate regime, inflation must grow at the same rate in each of the participating countries, at least in the long run. The model implies that reserve currency inflation causes world inflation. The mechanism by which inflation is transmitted when currencies are allowed to float is more complex. The long run international convergence of inflation is studied using modern time series techniques on post-war data from the G-7 countries. The evidence on the convergence of inflation during the fixed regime portion of the sample is strong and consistent with the notion of reserve currency causality, i.e. from the US to the rest of the world. The evidence of convergence over the floating portion of the sample is also quite strong, but no single currency can be characterized as the common underlying source of world inflation implying the inflation rates are endogenous.

The dynamic effects of aggregate demand and supply disturbances: Another look

Abstract In a recent paper, Blanchard and Quah ( American Economic Review , 1989, 79, 655–673) propose a set of restrictions to identify the structural innovations from a reduced-form bivariate model of income growth and unemployment. Given the assumptions made by Blanchard and Quah on the time-series properties of the data, this paper demonstrates that their bivariate model is just a special case of Stock and Watsons Journal of the American Statistical Association , 1988, 83, 1097–1107) common trends representation. More importantly, this alternative representation allows the econometrician to test the long-run restrictions used by Blanchard and Quah to distinguish between demand and supply innovations.