The Fisher effect in the EU revisited: new evidence using panel cointegration estimation with global stochastic trends

This article is aimed at verifying the fulfilment of the Fisher hypothesis for a panel of 15 EU countries using the recent developments in the estimation of panel cointegration models with cross-sectional dependence generated by unobservable global stochastic trends (Bai et al., 2009). Bai et al. (2009) propose two iterative procedures that jointly estimate the slope parameters and the stochastic trends. The resulting estimators are referred to, respectively, as Continuously Updated and Bias Corrected (CupBC) and Continuously Updated and Fully Modified (CupFM) estimators. Our results show that, if we ignore the cross-sectional dependence generated by global stochastic trends when estimating the Fisher equation, we could erroneously infer that there is a full Fisher effect, as found by Westerlund (2008) for a panel of OECD countries. However, if we explicitly introduce the common factors in the Fisher equation, the CupBC and CupFM estimators of the slope parameter on inflation are significantly lower than unity, which implies the existence of a 'partial' Fisher effect.