Inflation Uncertainty and Interest Rates : Is The Fisher Relation Universal?

Abstract

This paper tests the validity of the Fisher hypothesis, which establishes a positive relation between interest rates and expected inflation, for the G7 countries and 45 developing economies. For this purpose we estimate a version of the GARCH specification of the hypothesis for all countries included in the sample. We also test the augmented Fisher relation by including the inflation uncertainty into the equation. The simple Fisher relation holds in all G7 countries but in only 23 developing countries. There is a positive and statistically significant relationship between interest rates and inflation uncertainty for the six of the G-7 and 18 developing countries and this relationship is negative for seven developing countries.