Intertemporal Stability of the Relationship Between Interest Rates and Price Changes

Cargill, Thomas F.; Meyer, R.A.

doi:10.2307/2326508

Cited by 9 publications

(13 citation statements)

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“…First, the most direct approach is to posit a smooth relationship among expectations of different maturities and analytically fit a curve to the sample points. The frequently observed yield curve shape 7Tk = aO + a,e-a2k (6) and its special case Tk = ao(l -ea2k) (7) provide a useful starting point. Table I reports The most striking impression from these results is the almost total absence of stability in expectations from quarter to quarter.4 Only when observations were grouped on a purely empirical basis of relative stability did R2's even begin to edge above zero-and even this improvement was judged too slight to form a reliable basis for estimating the unobserved points on the term structure of expectations curve.…”

Section: Theoretical Model Formulationmentioning

confidence: 99%

“…where it is the observed percentage change in prices at time t. The coefficients in (9) can be approximated by Taylor series and truncated to permit estimation. A third approach is suggested by the apparently sharp divergences between 1950s and 1960s samples (e.g., Gibson [16] and Cargil and Meyer [6] [7]) and the purely statistical aberrations introduced by trends in economic data. Although prior to the 1960s no consistent trend in inflation existed, this is not true in the 1960s.…”

Section: Theoretical Model Formulationmentioning

confidence: 99%

“…Carlson used deviations of the capacity index from the mean value and a moving average measure of the liquidity variable, while we use the direct estimates of the capacity index and the percentage change in the level of the money supply. [7] was to investigate the stability issue over a long period of time. Other studies have also reached findings of intertemporal instability in the relationship.…”

Section: An Expanded Relationship Between Nominal Yields and Expementioning

confidence: 99%

“…Stability of the Relationship: A detailed study such as presented in [7] is not possible with the type of data and the time interval under consideration in this paper. The biannual nature of the Livingston data effectively rules out monthly and even quarterly analysis and the time interval from 1960 to 1975 limits-the number of subperiods that can be reasonably analyzed.…”

Section: Recent Literature On the Relationship Between Nominal Interementioning

confidence: 99%

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The Term Structure of Inflationary Expectations and Market Efficiency

Cargill¹,

Meyer²

1980

The Journal of Finance

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FISHER'S [15] ORIGINAL FORMULATION OF an equilibrium relationship in which a nominal interest rate is equal to a real rate of interest plus the expected rate of inflation has stimulated considerable interest and research. Although many empirical studies have utilized a single equation distributed lag specification1 of past price changes (which might be induced from a rational expectations argument) as a proxy for "expectations," T. F. Cargill and R. A. Meyer [5] have emphasized the necessity of a simultaneous equation structure if such distributed lags were to be employed. An alternative approach using Livingston's direct observations on expectations and allowing for the possibility of incomplete adjustment to expectations was employed by Cargill [2], W. Gibson [16] and D. Pyle [22]. These evolving improvements in conception of the empirical problem, data and econometric approach have led to a particularly interesting paper by K. Lahiri [18] in which S. Turnovsky's [25] expectations formation equations are coupled to the original Fisherian equation and then appropriate simultaneous equation techniques are applied to the resulting econometric relationships. From a slightly different perspective, E. Fama [13] has emphasized the implication for market efficiency embedded in the interest rate and expected inflation relationship. All analyses to date rest on the assumption that the real rate of interest is constant over time. Thus, as Fama noted, empirical implications for market efficiency tests really constitute a test of the joint hypothesis of efficiency and a constant rate.2 Despite the advances in conception of the empirical problem, data improvements, and improvements in econometric technique, the question of variation in the real rate of interest and the possibility of incomplete adjustment to changes in the real rate as well as to expected inflation leaves the extent and stability of the Fisherian relationship far from a settled matter. In addition, a much richer class of hypotheses emerges when Fama's emphasis on the market equilibrium aspects is carried further. No prior work has utilized any type of data to estimate the terni structure of expectations which is the key to Fisher's hypothesis when applied across maturities. In addition, the contributions of W. Sharpe [24] and J. Lintner [20] in providing an equilibrium capital asset pricing theory can be * The authors are professors,

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Section: Theoretical Model Formulationmentioning

confidence: 99%

Section: Theoretical Model Formulationmentioning

confidence: 99%

Section: An Expanded Relationship Between Nominal Yields and Expementioning

confidence: 99%

Section: Recent Literature On the Relationship Between Nominal Interementioning

confidence: 99%

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The Term Structure of Inflationary Expectations and Market Efficiency

Cargill¹,

Meyer²

1980

The Journal of Finance

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“…Numerous researchers have failed to find that strong an empirical effect on nominal rates, however, and some have expressed puzzlement over this empirical result. (The empirical literature includes [1], [2], [3], [5], [6], [1]0, [1][3], [1]4 and numerous others. )…”

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confidence: 99%

Expected Inflation and Interest Rates in a Multi‐asset Model: A Note

Mitchell

1985

The Journal of Finance

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This paper analyzes the effect of expected inflation on nominal interest rates, in a theoretical model with money and two different bond types. The inclusion of three assets instead of the usual two causes the effect of expected inflation on the interest rates to deviate from unity. Depending on the sizes of the wealth and interest rate effects on the various asset demands, the effect of expected inflation could even be negative. Several special cases are also considered, and the implications for the interpretation of empirical results are discussed. THE PROFESSION HAS SHOWN a continuing strong interest in the effect of expected inflation on interest rates, both from a theoretical and an empirical perspective. Fisher's [6]original hypothesis was that there should be a one-forone effect, so that expected inflation has no effect on the ex ante real interest rate. Numerous researchers have failed to find that strong an empirical effect on nominal rates, however, and some have expressed puzzlement over this empirical result. (The empirical literature includes [1, 2, 3, 5, 6, 10, 13, 14] and numerous others.) Theoretical models generally consider a short-run situation in which the real rate of return on financial assets is free to deviate from the marginal product of capital. The simplest possible such macro model, with IS, LM, and vertical aggregate supply curve equations, generates the Fisher result that dr/dir-the effect of expected inflation -r on the nominal interest rate r-equals unity. But there are several possible modifications to this model which can drive the value of dr/dir either up or down. First, the Mundell [12] effect states that the presence of a real balance effect on consumption depresses the value of dr/dir. Second, the Phillips effect [9, 10] states that a nonvertical aggregate supply curve depresses dr/d7r. Third, Levi and Makin [10] showed that if the level of expected inflation influences inflation uncertainty, and if inflation uncertainty in turn affects the parameters of any behavioral function, then this channel alters the value of dr/dir. And finally, the Darby [4] effect states that the presence of a tax on nominal interest income magnifies dr/dir. Recently, Carmichael and Stebbing [3] argued that bonds might be closer substitutes for money than for anything else, so expected inflation might have a

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Direct Evidence of the Darby Hypothesis for the United States

Cargill

1977

Economic Inquiry

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The empirical evidence on the Fisherian relationship between nominal interest rates and anticipated changes in prices has been the subject of extended discussion over the last decade; however, the recent contribution by M. Darby (1975) has provided important insight into the controversy.Darby makes the reasonable point that the existing tax structure will influence the response of interest rates to changes in anticipated prices.J. Carr, J. Pesando, and L. Smith (1976) have specifically investigated an important implication of Darby's version of the Fisherian model. Previous studies interpret a price coefficient of one as indicating that inflationary anticipations are fully incorporated into nominal interest rates; however, Darby points out that the coefficient should be significantly greater than one since the holder of a government security is subject to taxation on the interest income. Carr et a1 examined Canadian data using four well-known interest rate models and reached inconclusive results. The price anticipation coefficients had the correct positive sign; but were seldom greater than one. In those cases where the coefficients exceeded one they were not significantly greater than one. They concluded that the inconclusive results partly depended on the methods of measuring price anticipations which were based on past changes in the actual price level.A direct test of the Darby hypothesis is possible for the U.S. using the Livingston data base. The Livingston data base allows for direct estimates of anticipated price changes without resort to distributed lag methods of generating price anticipations. It should be pointed out, however, that the Livingston data base used to test the Darby hypothesis is not the one used in previous studies but represents revised estimates made by J. Carlson (3). These data were used in a previous study (Cargill, 1976) concerned with the temporal stability of the relationship between interest rates and anticipated price changes between the decades of the 1950's and 1960's. The results in that study can be used to directly test the Darby hypothesis. Table 1 presents the price anticipation coefficients for simple regressions of various nominal interest rates regressed on percentage changes in anticipated prices for t+8 and t+ 14 months.

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Intertemporal Stability of the Relationship Between Interest Rates and Price Changes

Cited by 9 publications

References 3 publications

The Term Structure of Inflationary Expectations and Market Efficiency

The Term Structure of Inflationary Expectations and Market Efficiency

Expected Inflation and Interest Rates in a Multi‐asset Model: A Note

Direct Evidence of the Darby Hypothesis for the United States

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