Inflation uncertainty and interest rates: is the Fisher relation universal?

TLDR

The study tests whether the Fisher hypothesis linking interest rates to expected inflation holds across G7 and 45 developing economies. The authors estimate a GARCH‑based Fisher model for all countries and augment it with inflation uncertainty to test the hypothesis. The simple Fisher relation is valid in all G7 but only 23 of 45 developing economies; interest rates are positively linked to inflation uncertainty in six G7 and 18 developing countries, but negatively in seven developing economies.

Abstract

This paper tests the validity of the Fisher hypothesis, which establishes a positive relation between interest rates and expected inflation, for the G7 countries and 45 developing economies. For this purpose, we estimate a version of the GARCH specification of the hypothesis for all countries included in the sample. We also test the augmented Fisher relation by including the inflation uncertainty in the equation. The simple Fisher relation holds in all G7 countries but in only 23 developing countries. There is a positive and statistically significant relationship between interest rates and inflation uncertainty for six of the G7 and 18 of the developing countries and this relationship is negative for seven developing countries.