Panel cointegration tests of the Fisher effect

TLDR

Most empirical evidence suggests that the Fisher effect, which predicts a unit‑slope cointegration between inflation and nominal interest rates, is not supported, contradicting many theoretical models. The study contends that the failure of univariate tests to detect the Fisher effect is partly due to low power and proposes that panel data can yield more powerful tests. Two new panel cointegration tests are introduced, shown by simulation to outperform existing tests, and applied to quarterly data from 20 OECD countries (1980‑2004). Panel evidence indicates that the Fisher effect cannot be rejected when cointegration is assessed with the proposed tests. © 2007 John Wiley & Sons, Ltd.

Abstract

Abstract Most empirical evidence suggests that the Fisher effect, stating that inflation and nominal interest rates should cointegrate with a unit slope on inflation, does not hold, a finding at odds with many theoretical models. This paper argues that these results can be attributed in part to the low power of univariate tests, and that the use of panel data can generate more powerful tests. For this purpose, we propose two new panel cointegration tests that can be applied under very general conditions, and that are shown by simulation to be more powerful than other existing tests. These tests are applied to a panel of quarterly data covering 20 OECD countries between 1980 and 2004. The evidence suggest that the Fisher effect cannot be rejected once the panel evidence on cointegration has been taken into account. Copyright © 2007 John Wiley & Sons, Ltd.