The Long-Run Relationship between Nominal Interest Rates and Inflation of the Asian Development Countries: A Commentary

Tuck Cheong Tang ()

Jurnal Ekonomi Malaysia, 2003, vol. 37, 135-139

Abstract: There has been widespread concern among policymakers about the relationships or inter-effects between interest rate and inflation. The empirical testing on these relations is widely applied based on Fisher hypothesis. Fisher (1930) had hypothesized that the nominal rate of interest was equal to the sum of both the real rate of interest and the expected rate of inflation, and exist a one-to-one relationship between the rate of interest and expected inflation assuming the real rate being independent of the rate of inflation. The Fisher effect, commonly referred to the movements in short- term interest rates primarily reflects fluctuations in expected inflation and, as such, they have predictive ability for future inflation. The Fisher hypothesis predicts that the coefficient on the rate of inflation equals to one, and is a long-run relationship; therefore, inflation could affect real interest rates in the short run. During the adjustment process, the real rale will change so that the nominal rate reflects both changes in real rates and inflationary expectations. In the long run, when all adjustments have occurred, the increase in inflation is fully incorporated in nominal interest rates.

Date: 2003
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