Martin Uribe on Neo-Fisher Effect - Dictionary of Arguments
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Def Fisher-Effect/Uribe: A large body of empirical and theoretical studies argue that a transitory positive disturbance in the nominal interest rate causes a transitory increase in the real interest rate, which in turn depresses aggregate demand and inflation (…) (see, for example,
Christiano, Eichenbaum, and Evans, 2005)(1). Similarly, a property of virtually all modern models studied in monetary economics is that a transitory increase in the nominal interest rate has no effect on inflation in the long run. By contrast, if the increase in the nominal interest rate is permanent, sooner or later, inflation will have to increase by roughly the same magnitude, if the real interest rate, given by the difference between the nominal rate and expected inflation, is not determined by nominal factors in the long run (...). This one-to-one long-run relationship between nominal rates and inflation is known as the Fisher effect.
Def Neo-Fisher Effect/Uribe: The neo-Fisher effect says that a permanent increase in the nominal interest rate causes an increase in inflation not only in the long run but also in the short run.
The Fisher effect, however, does not provide a prediction of when inflation should be
expected to catch up with a permanent increase in the nominal interest rate. It only states that it must eventually do so.
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Neo-Fisher Effect/Empirical Model/New-Keynesian Model/Inflation/Interest/Uribe:
Empirical model: The empirical model aims to capture the dynamics of three macroeconomic indicators (…): the logarithm of real output per capita (…), the inflation rate (…), expressed in percent per year, and the nominal interest rate (…), expressed in percent per year.
[Uribe] assume[s] that [the three indicators above] are driven by four exogenous shocks: a nonstationary (or permanent) monetary shock (…), a stationary (or transitory) monetary shock (…), a nonstationary nonmonetary shock (…) and a stationary nonmonetary shock (…).
[Uribe] estimate[s] the empirical model on quarterly U.S. data spanning the period 1954:Q3 to 2018:Q2.
The main result [from the empirical model] is that the adjustment of inflation to its higher long-run level takes place in the short run. In fact, inflation increases by 1 percent on impact and remains around that level thereafter. On the real side of the economy, the permanent increase in the nominal interest rate does not cause a contraction in aggregate activity. Indeed, output exhibits a transitory expansion. This effect could be the consequence of low real interest rates resulting from the swift reflation of the economy following the permanent interest-rate shock. Because of the faster response of inflation relative to that of the nominal interest rate, the real interest rate falls by almost 1 percent on impact and converges to its steady-state level from below, implying that the entire adjustment to a permanent interest-rate shock takes place in the context of low real interest rates.
How important are nonstationary monetary shocks? The relevance of the neo-Fisher effect depends not only on whether it can be identified in actual data, (…) but also on whether permanent monetary shocks play a significant role in explaining short-run movements in the inflation rate.
[T]he empirical model assigns a significant role to this type of monetary disturbance [the nonstationary monetary shock], especially in explaining movements in nominal variables. In comparison, the stationary monetary shock explains a relatively small fraction of movements in the three macroeconomic indicators included in the model.
[To summarize] the estimated empirical model predicts that a permanent increase in the nominal interest rate causes an immediate increase in inflation and transitional dynamics characterized by low real interest rates, and no output loss.
New-Keynesian Model: In this section the presence of a neo-Fisher effect in the context of an estimated standard optimizing model in the neo-Keynesian tradition [is investigated]. [The model] is driven by six shocks: permanent and transitory interest-rate shocks, permanent and transitory productivity shocks, a preference shock, and a labor-supply shock.
[Q]ualitatively, the responses implied by the New-Keynesian model concur with those implied by the empirical model (…). An increase in the nominal interest rate that is understood to be permanent by private agents (…) causes an increase in inflation in the short run, without loss of aggregate activity. By contrast, an increase in the nominal interest rate that is interpreted
to be transitory (…) causes a fall in inflation and a contraction in aggregate activity.
[I]n response to a permanent increase in the nominal interest rate inflation not only begins to increase immediately, but does so at a rate faster than the nominal interest rate. As a result, the real interest rate falls. By contrast, a temporary increase in the nominal interest rate causes a fall in inflation and an increase in the real interest rate. A natural question is why inflation moves faster than the interest rate in the short run when the monetary shock is expected to be permanent. The answer has to do with the presence of nominal rigidities and with the way the central bank conducts monetary policy. In response to a permanent
monetary shock that increases the nominal interest rate by one percent in the long run, the central bank raises the short-run policy rate quickly but gradually. At the same time, firms know that, by the Fisher effect, the price level will increase by one percent in the long run, and that they too will have to increase their own price in the same proportion in the long run, to avoid making losses. Since firms face quadratic costs of adjusting prices, they find it optimal to begin increasing the price immediately. Since all firms do the same, inflation itself begins to increase as soon as the shock is announced.
1. Christiano, Lawrence J., Martin Eichenbaum, and Charles L. Evans, “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy,” Journal of Political Economy 113, 2005, 1-45.
Martín Uribe (2019): The Neo-Fisher Effect: Econometric Evidence from Empirical and Optimizing Models. In: NBER Working Paper No. 25089._____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Concept/Author], [Author1]Vs[Author2] or [Author]Vs[term] resp. "problem:"/"solution:", "old:"/"new:" and "thesis:" is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition.
The Neo-Fisher Effect: Econometric Evidence from Empirical and Optimizing Models. NBER Working Paper No. 25089 2019