Dynamics of Interest and Inflation Rates

Journal of Empirical Finance, Vol. 39, Part A, December 2016

38 Pages Posted: 22 Dec 2016

See all articles by Ali Anari

Ali Anari

Texas A&M University - Mays Business School

James W. Kolari

Texas A&M University - Department of Finance

Date Written: December , 2016

Abstract

This paper proposes that there is a dynamic relationship between interest and inflation rates that are jointly determined due to the dual existence of Fisher and Wicksell processes. The Fisher process is the positive relationship between inflation and interest rates wherein causality runs from inflation to interest rates. By contrast, the Wicksell process is the negative relationship between the two rates with causality from interest to inflation rates. While Fisher and Wicksell theories are ex ante relationships, empirical tests employ ex post interest and inflation rate series after the full realization of both Fisher and Wicksell effects. This ex post estimation procedure has led to less than unity Fisher coefficients, known as the Fisher puzzle. We derive linkages between ex ante and ex post coefficients in the Fisher and Wicksell equations and propose methods for recovering ex ante coefficients from ex post estimated relationships. Application of these methods to U.S. data and several other advanced economies supports both Fisher and Wicksell theories of interest and inflation rates and helps to explain the Fisher puzzle.

Keywords: dynamics, inflation, interest rates, endogeneity, ex post and ex ante Fisher and Wicksell coefficients

JEL Classification: E31, E43, G12

Suggested Citation

Anari, Ali and Kolari, James W., Dynamics of Interest and Inflation Rates (December , 2016). Journal of Empirical Finance, Vol. 39, Part A, December 2016. Available at SSRN: https://ssrn.com/abstract=2888596 or http://dx.doi.org/10.2139/ssrn.2888596

Ali Anari (Contact Author)

Texas A&M University - Mays Business School ( email )

Wehner 401Q, MS 4353
College Station, TX 77843-4218
United States
979-845-2094 (Phone)
979-845-0460 (Fax)

James W. Kolari

Texas A&M University - Department of Finance ( email )

MS-4218
Department of Finance
College Station, TX TX 77843-4218
United States
979-845-4803 (Phone)
979-845-3884 (Fax)

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