Question

1. Go to FRED database and find data on the 1-year Treasury Rate (GS1) and the GDP Deflator price index (GDPDEF).  For GS1 choose the frequencysetting as “quarterly”; for the (GDPDEF) set the unitssetting to “Percent Change From Year Ago”; and download both data series.  For the questions below assume inflation is a good proxy for inflation expectations.

1. From the current period of data available, compare inflation and the interest rate to what it was in 2010: Q1.  Does the Fisher effect hold? Why or why not?
2. From the current period of data available, compare the inflation and the interest rate to what it was in 1990: Q1.  Does the Fisher effect hold?  Why or why not?

Answer 1

Answer:-

a)

During the span of 11 years, the inflation rate changed from 3.1 in the first quarter of 2005 to 1.2% in the first quarter of 2011. Gross Domestic Product: Implicit Price Deflator had declined by 1.9% in these 10 years. During the same time interest rate changed from 3.06% in Q1 of 2010 to 0.58% in Q1 of 2021. The 1-Year Treasury Constant Maturity Rate has decreased by around 2.48%.

The decrease in interest rate is much more than the fall in inflation. From the assumption under classical dichotomy states that the real variable remains unaffected which does not hold here. Hence, the Fisher effect does not hold at all.

b)

During the span of 36 years, the inflation rate changed from 8.9% in the first quarter of 1990 to 1.2% in the first quarter of 2011. Gross Domestic Product: Implicit Price Deflator had declined by 7.7% in these 36 years. During the same time interest rate changed from 13.93% in Q1 of 1980 to 0.58% in Q1 of 2021. The 1-Year Treasury Constant Maturity Rate has decreased by around 13.35%.

The decrease in interest rate is much more than the fall in inflation. From the assumption under classical dichotomy states that the real variable remains unaffected which does not hold here. Hence, the Fisher effect does not hold at all.