The nominal interest rate as a predictor of inflation: a re-examination of the underlying model

This paper examines the viability of using short-term interest rates to forecast inflation as implied by the Fisher hypothesis. A major problem with this approach is the implicit assumption that the real interest rate is constant and that the relationship between inflation and interest rate does not change over time. We demonstrate, using US quarterly data, that the relaxation of these assumptions produces a model with a higher degree of forecasting accuracy and efficiency.