Non-linear Co-integration between Nominal Interest Rates and Inflation: An Examination of the Fisher Hypothesis for Asian Countries

This paper examines the long-run relationship between nominal interest rates and inflation for a group of Asian countries over the period February 1973-April 2007. We argue that the empirical failure to find evidence supporting the Fisher effect in previous studies may be attributed to the presence of non-linearities in the long-run relationship between nominal interest rates and inflation. We present evidence that the Fisher relation contains significant logistic smooth transition autoregression (LSTAR)-type non-linearity. This type of non-linearity is consistent with inflation targeting and the opportunistic behavior of policy-makers. Applying a non-linear unit root test to the residuals obtained from the Fisher relation decisively rejects the null hypothesis of a unit root against the alternative of non-linear but globally stationary in all the cases.