Are Expected Inflation and Expected Real Return Negatively Correlated? A Long-Run Test of the Mundell-Tobin Hypothesis

Some empirical evidence suggests that the expected real interest and expected inflation rates are negatively correlated. This hypothesis of negative correlation is sometimes known as the Mundell-Tobin hypothesis. In this paper, we reinvestigate this negative relation from a long-term point of view using co integration analysis. The data on the historical interest rate on T-bills and the inflation rate indicate that the Mundell-Tobin hypothesis does not hold in the long run for the United States, the United Kingdom and Canada. We also obtain similar results using the real interest rate on index-linked gilt traded in the United Kingdom