New Empirical Evidence for the Fisher Relation : Integration and Short-Run Instability

The Fisher relation is a key theoretical relation that underlies many important results in economics and finance. Although the Fisher relation is apparently simple in theory, empirical analyses of the relation have mixed and weak results. We consider the possibility that weakness of the evidence is due to short-run instability in the relation, which is sufficiently strong to dominate the whole sample. We analyze this possibility based on the following two approaches. First, we apply partial-sample instability tests of Andrews and Kim (2006) to detect such short-run instability. Our result shows clear evidence for the existence of such short-run instability. Second, we examine how much the partial-sample instability affects the long-memory property of the real interest rate based on the concept of fractional integration. Our result indicates that the short-run instability causes a substantial increase in the coefficient of fractional integration, which implies an increase in the tendency of nonstationarity