When the Fisher effect
is applied to the stock returns/inflation relationship, it is suggested that stocks would move one-to-one with inflation, thus making stocks a hedge for inflation.
This Fisher effect
is well known and is not likely to be disputed in macroeconomic circles.
The Fisher Effect
maintains that the nominal interest rate is a function of the real interest rate and the inflation rate.
Studies by McDonald and Murphy (1989), Mishkin (1992), Wallace and Warner (1993), Phylaktis and Blake (1993), Evans and Lewis (1995), Lee (2007), and Hatemi-J (2009) supported the general view that changes in nominal long-bond interest rates reflect fluctuations in expected inflation, but not to the extent of the full one-to-one Fisher effect
Empirical findings obtained from this approach are abundant but inconclusive thus far; see Cooray (2003) and Johnson (2006) who provide excellent overviews of the theoretical and empirical issues on the Fisher effect
Here if the interest and inflation variables are nonstationary and have the same level of unit root structure (mostly I(1)), they may co-move together, establishing a long run common trend and in the process uphold the Fisher Effect
First, in terms of anticipated component of inflation, we find that the Fisher effect
appears to hold at short horizons, where expected inflation has insignificant short-run impacts on real stock returns but not at longer horizons and where anticipated inflation is found to have negative long-run impacts on real stock returns.
Secondary issues examined include interest-rate changes in the economy overtime and the Fisher Effect
Even if the Fisher relation does hold, it is unlikely that the Fisher effect
will be one-for-one, as implied by defining the real interest rate from the simple Fisher equation.
The International Fisher Effect
(IFE) theory is an important concept in the fields of economics and finance that links interest rates, inflation and exchange rates.
Their views are shared by Mankiw , explaining that the Fisher effect
did not hold during the late nineteenth and the early twentieth centuries due to the gold standard monetary system.
Since inflationary expectations influence nominal interest rate, the Fisher effect
has far-reaching implications for debtors and creditors as well as for the effectiveness of monetary policy and efficiency in banking sector.