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Journal ArticleDOI

Price‐expectations effects on interest rates

01 Mar 1970-Journal of Finance (Blackwell Publishing Ltd)-Vol. 25, Iss: 1, pp 19-34
TL;DR: The relationship between the expected rate of change of prices and the level of interest rates enjoys special status in economic theory as discussed by the authors, and empirical verification of price-expectation effects warrants more attention, not only to substantiate the theory but also as a guide in formulating and evaluating national economic policy.
Abstract: THE RELATIONSHIP BETWEEN the expected rate of change of prices and the level of interest rates enjoys special status in economic theory. The positive relationship hypothesized long ago by Irving Fisher is widely accepted by students of economic theory, while its existence for United States experiences has, it appears, yet to be conclusively demonstrated. The absence of measurement of the relationship seems, however, not to have detracted greatly from its theoretical acceptability. Empirical verification of price-expectations effects warrants more attention, not only to substantiate the theory but also as a guide in formulating and evaluating national economic policy. A combination of monetary and fiscal policies which brings about prolonged inflation should by doing so tend also to increase market interest rates. These interest rate increases have important implications for saving and investment behavior and for the demand for money. If we are to assess the importance of these effects, we need some idea of their magnitude and timing, and this paper attempts such an estimation. In the next section the theoretical formulation of the price-expectations effect will be reviewed, while section III presents new evidence on the effects for U.S. data, and section IV concludes the paper.
Citations
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Journal ArticleDOI
TL;DR: The authors investigated the relation between common stock returns and inflation in twenty-six countries for the postwar period and found that there is a consistent lack of positive relation between stock returns with inflation in most of the countries.
Abstract: This paper investigates the relation between common stock returns and inflation in twenty-six countries for the postwar period. Our results do not support the Fisher Hypothesis, which states that real rates of return on common stocks and expected inflation rates are independent and that nominal stock returns vary in one-to-one correspondence with expected inflation. There is a consistent lack of positive relation between stock returns and inflation in most of the countries.

427 citations


Cites methods from "Price‐expectations effects on inter..."

  • ...See Gibson [15, 16] and Fama and Schwert [9], for example....

    [...]

Journal ArticleDOI
TL;DR: In this article, the authors analyzed monetary policy effects on interest rates in terms of liquidity, income, and expectations effects, and showed that substitution among securities will increase as time elapses and so reduce or eliminate financial effects caused by short-run financial market segmentation.
Abstract: SUMMARY Standard analysis of monetary policy effects on interest rates in terms of liquidity, income, and expectations effects is incomplete. After a change in monetary policy, substitution among securities will increase as time elapses and so reduce or eliminate financial effects caused by short-run financial market segmentation. Also, the standard expectations effect omits the transfer of income tax liability on that part of the interest payment representing a return of real capital. So a 1 percentage point increase in the expected inflation rate should increase the nominal interest rate by 1/(1 —τ) percentage points, τ being the marginal tax rate.

390 citations

Book ChapterDOI
Abstract: Inflation is a process of continuously rising prices, or equivalently, of a continuously falling value of money Its importance stems from the pervasive role played by money in a modern economy A continuously falling value of pins, or of refrigerators, or of potatoes would not be regarded as a major social problem, important though it might be for the people directly engaged in the production and sale of those goods The case of money is different precisely because the role that it plays in co-ordinating economic activity ensures that changes in its value over time impinge upon the well-being of everyone

306 citations

Journal ArticleDOI
TL;DR: A consensus has emerged among practitioners that the instrument of monetary policy ought to be the short-term interest rate, that policy should be focused on the control of inflation, and that inflation can be reduced by increasing shortterm interest rates.
Abstract: A consensus has emerged among practitioners that the instrument of monetary policy ought to be the short-term interest rate, that policy should be focused on the control of inflation, and that inflation can be reduced by increasing short-term interest rates. At the center of this consensus is a rejection of the quantity theory. Such a rejection is a difficult step to take, given the mass of evidence linking money growth, inflation, and interest rates: increases in average rates of money growth are associated with equal increases in average inflation rates and interest rates. These observations need not rule out a constructive role for the use of short-term interest rates as a monetary instrument. One possibility is that increasing short-term rates in the face of increases in inflation is just an indirect way of reducing money growth: sell bonds and take money out of the system. Another possibility is that, while control of monetary aggregates is the key to low long-run average inflation rates, an interest-rate policy can improve the short-run behavior of interest rates and prices. The shortrun connections among money growth, inflation, and interest rates are very unreliable, so there is much room for improvement. These possibilities are surely worth exploring, but doing so requires new theory. The analysis needed to reconcile interest-rate policies with the evidence on which the quantity theory of money is grounded cannot be found in old textbook diagrams.

207 citations

Journal ArticleDOI
TL;DR: In this article, an empirical study of the effects of Federal government borrowing on short-term interest rates is presented, and it is shown that Federal borrowing is a relatively unimportant (and insignificant) determinant of short term rates.
Abstract: This paper is an empirical study of the effects of Federal government borrowing on short term interest rates. It is often taken for granted that increases in Federal borrowing cause higher short term rates, but little empirical support exists for this assumption. In fact, this paper demonstrates that Federal borrowing is a relatively unimportant (and insignificant) determinant of short term rates. An implication of this result is that financial crowding-out effects of government deficit spending may not be overly large. Postulates about interest rate behavior are the driving force behind many hypotheses of the crowding-out literature. However, these interest rate effects have received relatively little direct attention in this literature. This is surprising since, as a general rule, the stronger the interest rate effect is, the stronger the crowding-out effect will be. An empirical determination of the size of the deficit spending interest rate effect gives some empirical content to the crowding-out controversy. In Section II of this paper, the relationship between Federal borrowing, interest rates, and crowding-out is discussed and a loanable funds model of short term interest rates is developed. In Section III, the regression model is generated and tested. The essential result is that variation in three month Treasury Bill rates is caused by expected inflation, changes in the monetary base, and by changes in the level of economic activity. There is no statistically significant relation between short term interest rates and Federal borrowing. In Section IV, additional regression tests are performed which confirm the results in Section III, and the problem of simultaneous equation bias is discussed. The final part of the paper is a discussion of some implications of the results reported in Sections III and IV.

181 citations