The Fisher Effect: Inverted or Not?

In recent years, the Fisher Effect -- that nominal interest rates rise on a one-for-one basis with respect to anticipated inflation -- has been challenged in the financial literature. Furthermore, some researchers have suggested that, when nominal interest rates are viewed on an aftertax basis, there is no relationship with expected inflation. This suggests that the real, aftertax interest rate must fluctuate inversely over time with anticipated inflation (the inverted Fisher Hypothesis). Regression analysis is used to empirically challenge the existence of the inverted Fisher Effect and to argue that the adjustment of interest rates to anticipated inflation is in line with Fisher's theories. The data consist of the one-year forecasts for the Consumer Price Index from the Livingston Price Expectations series. The municipal and Treasury bill yields are from Salomon Brothers' Analytical Record of Yields and Yield Spreads. Semiannual observations are taken in June and December from 1953 to December 1983. The results are strongly supportive of Fisher's hypothesis about nominal and real interest rates over time.