Interest rates and inflation: A continuous time stochastic approach

A. G. Malliaris, Walter F. Mullady and M. E. Malliaris
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A. G. Malliaris: Loyola University of Chicago, Chicago, IL 60611, USA
Walter F. Mullady: Loyola University of Chicago, Chicago, IL 60611, USA
M. E. Malliaris: Loyola University of Chicago, Chicago, IL 60611, USA
Authors registered in the RePEc Author Service: Anastasios G. Malliaris and Mary E. Malliaris

Chapter 4 in Economic Uncertainty, Instabilities and Asset Bubbles:Selected Essays, 2005, pp 23-28 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractThis paper investigates the theoretical foundations of Fisher's equation which expresses the nominal interest rate as the sum of the real interest rate and the expected rate of inflation. To emphasize Fisher's (1930) original formulation and Sargent's (1973) recent suggestion that nominal interest rates and inflation are simultaneously determined rather than having the causation go from inflation to interest rates, we develop a two-equation continuous time stochastic model to build a more solid theoretical foundation of Fisher's equation. Assuming that the nominal interest rate and the rate of inflation follow Itô processes we derive an Itô equation that allows us to express and compute the expected real interest rate and its volatility. These two equations generalize the traditional Fisher equation and an illustration using US long data from 1865–1972 shows the usefulness of our results.

Keywords: Asymptotic Economic Growth; Inflation; Interest Rates; Asset Pricing; Equity Markets; Foreign Currency; Monetary Policy; Crash (search for similar items in EconPapers)
JEL-codes: C58 C73 E31 E37 E43 G12 G17 (search for similar items in EconPapers)
Date: 2005
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Journal Article: Interest rates and inflation: A continuous time stochastic approach (1991)
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