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A study of Fisher Effect in India
1Research Scholar, Mumbai School of Economics and Public Policy (Autonomous), University of Mumbai, Maharashtra, India.
Indian Economic Review
|June 26, 2023
Summary
This study examined the Fisher Effect in India, finding a negative long-run relationship between expected inflation and interest rates, contrary to theory. This suggests a disconnect possibly due to monetary policy shifts.
Area of Science:
- Economics
- Monetary Policy
- Econometrics
Background:
- The Fisher Effect posits a positive relationship between expected inflation and nominal interest rates.
- Understanding this relationship is crucial for monetary policy and financial market stability.
Purpose of the Study:
- To analyze the relationship between nominal interest rates and expected inflation in India based on Fisher Effect theory.
- To investigate the long-run cointegration and causality between expected inflation and interest rates using various measures.
Main Methods:
- Autoregressive Distributed Lag (ARDL) bounds testing approach.
- Granger causality test.
- Analysis using Core index, Wholesale Price Index (WPI), and Consumer Price Index (CPI) for inflation, and call money and treasury bill rates.
Main Results:
- Evidence of a cointegrating relationship between expected inflation and interest rates in India.
- Contrary to the Fisher Effect, a negative long-run relationship was observed.
- Granger causality was found between expected WPI inflation and interest rates, and between expected CPI inflation and interest rates, despite a lack of cointegration for CPI.
Conclusions:
- The study indicates a divergence between expected inflation and nominal interest rates in India.
- Factors such as flexible inflation targeting and multiple monetary policy objectives may explain this disconnect.
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