Economics, Econometrics and Finance
4 years ago

Interest rates fail to adjust to inflation, impacting global economic stability.

National Bureau of Economic Research
The Nonadjustment of Nominal Interest Rates: A Study of the Fisher Effect
Lawrence H. Summers

Paper Summary

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Macroeconomic Analysis

The study found that interest rates do not always adjust in response to inflation as expected by traditional economic theories. From 1860-1940, inflation did not significantly impact interest rates. Even in the post-war period, the effect of inflation on interest rates was smaller than predicted. The strongest relationship between inflation and interest rates was seen from 1965-1971. Real interest rates and stock market yields suggest that money illusion, rather than cyclical factors or measurement errors, may be the reason for interest rates not adjusting perfectly to expected inflation.