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“Fisher Effect” is the famous theoretical assumption about the interest rate and inflation rate. The paper first elaborates the basic principle of “Fisher Effect” theory, then finds the “Fisher Paradox” that may exist in China’s economy from the domestic and foreign scholars’ empirical study. Moreover, based on the data of China in 1980-2012, we conduct the Granger Causality Test of “Fisher Effect” and preliminarily conclude that from the empirical perspective, China does not exist long- term stable relationship between interest rate and inflation rate. Finally, it explains China’s “Fisher Paradox” root in the controlling characteristics of interest rate from policy perspective.

In the 20s to 30s of 20th century, capitalist countries had completed the transition from free capitalism to monopoly capitalism. At the same time, capitalism contradictions were intensified and exploded a severe economic crisis. In such a big background, traditional economics gradually developed to the modern economics. During this period, economists like Robinson, Chamberlain, Irving Fisher, etc., played a role in inheriting the past and ushering in the future.

The famous “Fisher Effect” reveals the relationship among nominal interest rate, actual interest rate and inflation rate, which is always an important problem in macro economics and finance research [

The relative purchasing power parity theory corresponds to the absolute PPP theory. The relative (PPP) means: in any given period of time, the changing percentage of two kinds of currencies’ exchange rate will equal to the difference of the two countries’ changing percentage of price level at the same time, just as formula (1).

Among them, _{t} denotes the rate of inflation.

According to formula (1), we get the changing percentage of the dollar/euro exchange rate is equal to the difference between the rate of inflation, so people would expect the dollar/euro exchange rate will equal to the difference between the two countries expected inflation rate. That is, convert the changes of real exchange rate and inflation into the changes of expected exchange rate and inflation, as formula (3).

Among them,

The Fisher believes that money demand can use

on, which has nothing to do with the rate of inflation and its value changes rarely, therefore can be considered as constant. So when the actual inflation rate is equal to the nominal rate of inflation, nominal interest rate and real interest rate is equal. We can explain it from the angle of the borrowers, assuming the borrowing rate is 2%, the expected inflation rate is 20%, when interest rate is lower than 22% the lenders are not willing to lend money to borrowers. In a word, we once again prove that the rate of inflation will affect nominal interest rate.

The Strict “Fisher Effect” theory thinks that: in the situation of rational expectations, effective market should compensate the change of the purchasing power of money in the long term, which means the nominal interest rate and inflation rate is one-to-one, the change of the price of any product cost will be displayed in the monetary cost, currency holding cost is basically equivalent with the product cost. If “Fisher Effect” exists, it means that money is super neutral and there is no money illusion, so nominal interest rate could be a good indicator variable of expected inflation rate. “Fisher Effect” is a judgment of monetary policy mechanism. Krugman found some important phenomenon in the empirical study of international economics: although purchasing power parity (PPP) went rotten in empirical research, “Fisher Effect” was confirmed in the large scope [

However, “Fisher Effect” that proved by Krugman is questioned by many scholars. Opponents think it is very difficult to verify the long-term equilibrium relationship between the two in practice. They believe in the open economy, the change tendency of the nominal interest rate and inflation rate is different, the sign of “Fisher Effect” is not obvious, thus put forward the “Fisher Paradox”. A lot of researches use the cointegration test of time series method, while the conclusion miss by a mile: King and Watson rejected the long-term equilibrium relationship between the two [

In the economical operation of china, the change of nominal interest rate and inflation rate is not only closely related in some periods, but also keep separate in other periods. Since 2006, China’s CPI reaches new highs, although most inflations belong to structural inflation, huge capital account surplus does provide a steady stream of liquidity. The focus of the empirical research is that whether there is a long-term stable relationship among the inflation rate, interest rate and interest rate policy in China.

Towards “Fisher Effect”, economic scholars’ research is increasingly high-end, the methods of studying “Fisher Effect” trend mathematical statistics. In this article, we adopt Granger causality test to do preliminary empirical inspection of “Fisher Effect” in china’s economy. The empirical variables are 1980-2009 China’s inflation rate and the nominal interest rate, which are set by the Chinese central bank, and the data come from 1980-2009 “China statistical yearbook”.

The main idea of Granger test is: in order to test the causality between X and Y, first estimate the degree of Y explained by its own lag, following verify the degree of Y after introduction of the lag value of X, if it can improve the explaining degree of Y, X will be the Granger cause of Y, specific content is as follows.

Assume that U_{n} is all information set until t stage, X_{n} is the information set of X until t stage, U_{n} − Y_{n} is all information except X until t stage, _{t} + 1. If we have formula (4), we can think variable X is the Granger cause of Y. Information set U_{n} includes all relevant information. If in the information set of U_{n}, information X can improve the prediction of Y, we say relative to the information set of U_{n}, X is the Granger cause of Y.

According to the above definition, assume that the information set U_{n} only consists of sequence X_{t}, Y_{t}, and X_{t}, Y_{t} is zero mean stationary variables. The concrete practice of Granger test is first to do constraint regression and unconstrained regression of formulas (5) or (6), and then apply the two residual sum of squares to calculate F-statistic and conduct the test.

Assume that X not the Granger cause of Y, the null hypothesis test of (5) function is: if the null hypothesis is satisfied, we will have formulas (7) and formula (8).

Among them,

Under the confidence level

In this paper, in order to test whether interest rate changes is Granger cause of inflation rate, firstly, we should test whether the time series of China’s inflation rate is steady. On the basis of SIC criteria, we conduct ADF root test to judge stationary of inflation rate and interest rate sequences. Test results show that inflation rate sequence is stationary while the interest rate sequence needs to do first order difference in order to reach significant level, see

The treated sequence can be used for Granger test, and the result of Granger test of inflation rate and interest rate sequence are listed as

Test results show that the P value is big and the F value is small, so we can’t reject null hypothesis: inflation rate does not Granger Cause of interest rate; interest rate does not Granger Cause of inflation rate, the causal feedback contact does not exist. Although the Granger test can’t fully reflect the reality, we can at least explain China existing “Fisher Effect” from the point of statistics―there is no long-term stable relationship between the

t-Statistic | Prob.* | t-Statistic | Prob.* | ||||
---|---|---|---|---|---|---|---|

ADF test statistic | −3.37289 | 0.0196 | ADF test statistic | −4.663039 | 0.0008 | ||

Test critical values | 1% | −3.65373 | Test critical values | 1% | −3.661661 | ||

5% | −2.95711 | 5% | −2.960411 | ||||

10% | −2.61743 | 10% | −2.619160 |

Note: The left column is the test of inflation rate sequence, and the right side is the test of interest rate sequence. The right side of the table is the testing result of interest rate sequence after a first order difference.

Null Hypothesis | Obs | F-Statistic | Prob. |
---|---|---|---|

Inflation rate does not Granger Cause of interest rate | 32 | 1.11839 | 0.2990 |

Interest rate does not Granger Cause of inflation rate | 1.05054 | 0.3139 |

nominal interest rate and inflation rate.

As existing “Fisher Paradox” in China’s economic, we initially inform that there is no significant causal link between the inflation rate and interest rate in current. Inflation is mainly due to the expansion of quickly increasing demand, and it is closely related to the monetary and fiscal expansion expenditure exceeding the growth of supply. We will analyze “Fisher Paradox” in two ways.

Before 1996, there was no deregulation of interest rates in China and inflation rates had very weak influence in interest rates. After 1996, our country gradually implemented market-oriented interest rate reform, so that the nominal interest rate could be in line with market rates. But China’s interest rate market regulation was still strong .Through analyzing of “Fisher effect” theory, we could know that residents will be able to make a reasonable inflation expectations timely through changes of interest rates when the nominal interest rate market trend is very strong. However, due to China’s interest rates market regulation features are very significant, interest rate can’t be flexible to conduct monetary policy and even cause distortion, so the residents’ inflation expectations appear bias. Inflexibility in nominal interest rate directly causes greater deviation between the expected inflation rate and the actual inflation rate, which weakens the link between nominal interest rate and inflation rate in some extent. It results in converse direction changes between real interest rate and inflation rate, which is “Fisher Paradox”.

There was a strict “Fisher Effect” in most developed countries. When the United States crisis spread to global countries, the real economy of all countries suffered strikes in varying levels. With price level and economic growth were falling, whether socialist or capitalist countries strengthened the intensity of macroeconomic regulation and controlling in order to avoid a recession. While monetary policy was used as an important means to regulate the economy, the United States, Europe, Japan and other major capitalist countries cut interest rates. This fully reflected that the linkage mechanism among the rate of inflation (declining in economic crisis), monetary policy and interest rate was one-to-one. China’s government had repeatedly cut interest rate in face of the economic crisis. But what was different with the west countries was that China’s interest rate policy was the central bank-led and directly affected on the market. While the capitalist countries were market-driven, central bank formulated appropriate policies complying with changes in market interest rate.

We can find that national monetary policy seems to fit “Fisher Effect” even in face of recession in economic crisis, which is in order to stabilize the economy and financial operations for purpose. But clearly, the actual main entities are different, which result in monetary policy and interest rate policy are always in line with “Fisher Effect” whether low inflation or high inflation during the recession period or economic overheating. However, China’s linkage effects of currency and interest rate exist differences no matter in economic overheating period or in the general period. Market regulation features are obvious.

“Fisher Effect” theory based on interest rate is very sensitive to the price. But in the current circumstances, China’s interest rate policy is commonly issued by administrative orders, so that the interest rate policy in China is lack of effective transmission mechanism and the reaction mechanism, interest rate policy has not completely combined with market economy (Qunyong Wang and Na Wu, 2009) [

China should further strengthen the reform of the interest rate market, letting interest rate more in line with the market trend, and reduce administrative intervention, making interest rate become an important signal of transmitting monetary policy and an important lever of macroeconomic regulation. Looking the experience of inflation management in China, administrative intervention will cause greater damage to economic entity, only “soft landing” that conforms to the market rule could make the economy gradually return to a normal level. Facing the high CPI index and structural inflation, interest rate only accords with the market economy law can it correctly guide for people’s rational expectations, the economy could gradually to smooth over. At the same time, formulation of interest rate should be timely, reduce the time lag and intervention, thus the rapid response of microscopic main body to interest rate could help them form a rational judgment on the monetary policy and inflation and adapt to changes of economy. According to “Fisher Effect” theory, because the expansion monetary policy cannot be sensitive to increase inflation pressure, we believe that the expansion of credit scale and moderately lower nominal interest rate is still an important option for the macroeconomic regulation, which helps achieve stable economic growth. At the same time, in face of the current inflation in the economy, focusing on solving supply lag problem caused by fiscal investment and adjusting economic structure is useful policy that accords with the economical practice.

ChaofanChen, (2015) “Fisher Effect” Theory and “Fisher Paradox” in China’s Economy. Open Journal of Social Sciences,03,80-85. doi: 10.4236/jss.2015.310012