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This article analyzes the asymptotic behavior of the Dickey–Fuller unit root tests when the variable is generated under the breaking trend hypothesis. Our results show that the asymptotic behavior of these statistics allows for the rejection of the unit root hypothesis. This asymptotic finding contrasts with the results that can be found in the literature devoted to the analysis of the integration order of a variable in the presence of a structural break. However, some Monte Carlo exercises show that the argument of Perron (1989, Econometrica 57, 1361–1401) that the tests are biased in favor of nonrejection of the unit root hypothesis remains valid for sample sizes of practical interest.

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This study reconsiders the common unit root/co-integration approach to test for the Fisher effect for the economies of the G7 countries. We first show that nominal interest and inflation rates are better represented as I (0) variables. Later, we use the Bai-Perron procedure to show the existence of structural changes in the Fisher equation. After considering these breaks, we find very limited evidence of a total Fisher effect as the transmission coefficient of the expected inflation rates to nominal interest rates is very different than one.

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The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.

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