INTERTEMPORAL STABILITY OF THE RELATIONSHIP BETWEEN INTEREST RATES AND PRICE CHANGES

Abstract

WHILE THE FIRST RIGOROUS STATEMENT of the relationship between interest rates and anticipated price charges is due to I. Fisher [9] over seventy years ago, the subject has been most enthusiastically studied during the last decade. A partial listing of recent studies would include: L. C. Anderson and K. M. Carlson [1], T. F. Cargill and R. A. Meyer [6], Cargill [4], M. Feldstein and 0. Eckstein [8], W. E. Gibson [10] [1 1] [12], M. J. Hamburger and W. L. Silber [13], D. Pyle [17], T. J. Sargent [18], and W. P. Yohe and S. S. Karnosky [21]. Fisher's original formulation was expressed in terms of anticipated price changes; however, the lack of a generally accepted measure of anticipated prices has lead to the widespread use of distributed lag functions of past price changes as a proxy for anticipated price changes. Thus the majority of studies on the Fisherian relationship really embed two hypotheses: (1) that actual past price changes embody information about anticipated price changes and (2) anticipated price changes influence nominal rates of interest. With the exception of the papers by Gibson, Pyle, and Cargill, studies of the Fisherian relationship have only provided indirect rather than direct evidence. The majority of studies have lead to several widely accepted implications about the Fisherian relationship. First, there is a significant statistical relationship between past price changes and interest rates. Adjustment coefficients are often less than one and tend to vary inversely with the maturity of the interest rate. Second, the positive relationship between interest rates and price changes is characterized by a long distributed lag response of interest rates to price changes. The only exception to this finding occurs for the period from 1950 through 1970 where lags of less than two years have been observed. Third, despite the long periods of time studied, variety of data bases, and estimation procedures employed, many studies concluded that past price changes account for a significant amount of the variation in rates of interest as measured by the computed R2 and that the regression coefficients are both positive and significant at conventional significance levels. The state of the empirical evidence is best summed up by Gibson in a recent paper: .....while the matter was in doubt just a few years ago, it now appears true that interest rates have indeed responded to changes in price expectations in the United States. [12, p. 753]. The extensive number of studies on the Fisherian relationship may be open to