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IMF Staff Papers Logo    Last updated: July 2002
Volume 49, Number 2
 
The Inverted Fisher Hypothesis:
Inflation Forecastability and Asset Substitution

Woon Gyu Choi

Full Text of this Article (PDF 289K)

Abstract: This paper examines the implications of inflation persistence for the inverted Fisher hypothesis that nominal interest rates do not adjust to inflation because of a high degree of substitutability between money and bonds. It is emphasized that the substitutability between nominal assets and capital renders the hypothesis inconsistent with the data when inflation persistence is high. Using a switching regression model, the analysis allows the reflection of inflation in interest rates to vary according to the degree of inflation persistence or forecastability. The hypothesis is supported by U.S. data only when inflation forecastability is below a certain threshold.
[JEL C51, E43]