The Inverted Fisher Hypothesis: Inflation Forecastability and Asset Substitution

This paper examines the implications of inflation persistence for the inverted Fisher hypothesis (IFH) proposed by Carmichael and Stebbing (1983, henceforth CS). The standard Fisher hypothesis implies that the real interest rate is not affected by inflation because of the substitutability between bonds and capital. In contrast, CS argue that this hypothesis becomes inverted if there is a high degree of substitutability between money and bonds and if government regulation precludes the...
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This paper examines the implications of inflation persistence for the inverted Fisher hypothesis (IFH) proposed by Carmichael and Stebbing (1983, henceforth CS). The standard Fisher hypothesis implies that the real interest rate is not affected by inflation because of the substitutability between bonds and capital. In contrast, CS argue that this hypothesis becomes inverted if there is a high degree of substitutability between money and bonds and if government regulation precludes the payment of interest on money.2 They propose that the nominal interest rate does not adjust to inflation, with the real interest rate moving inversely one-for-one with inflation. However, they presuppose that the inflation process is stationary (that is, nonpersistent).