Price‐expectations effects on interest rates

TLDR: 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.