Everyone’s a neo fisherian now!

The most important thing one can do in markets is keep up with what everyone else is thinking – and here’s something I’ve noticed recently. Neo Fisherian thinking is now so widespread on dealing floors that there’s barely any point in espousing it any more.

To those with better things to do and the uninitiated, Neo Fisherianism basically restates the identity that

r =  n  – i   (real interest rates = nominal interest rates  – inflation)

And points out that if ‘r’ is somehow fixed by the market, and you move ‘n’, ‘i’ will therefore have to make up the difference. ie, if you have 1% real rate, 3% nominal rate and 2% inflation, and you move the nominal rate to 1%, inflation will have to go to 0% to accomodate it.  This stands in sharp contrast to monetary orthodoxy – where it’s generally assumed that increasing nominal interest rates affects the real rate too, and that inflation is determined exogenously.

The coincident global loosening of monetary policy combined with falling commodity prices and low levels of output in general have created a ripe climate for belief in this idea. Moreover, if you look back in Western economic history, it’s easy to pull up charts that show inflation and nominal rates moving together – for example the oil shocks of the 70’s and early 80’s which meant that central bankers were forced to hike rates to very high levels to respond to unexpected inflation. Indeed, today’s environment is rather similar but in reverse – with a large unexpected decline in commodity prices effectively preventing central banks from tightening policy even after they stated many times that the would (dot plot?).

As ever in economics however, it’s possible for many things to be true at once and not possible to rule much out! In fact, even the strong version of the neo-fisherian claim – that if real interest rates are determined exogenously then nominal rates and inflation must move together, contains the “IF” contingency about real rates. If it doesn’t it’s nonsense. If inflation shocks are exogenous – let’s say a government puts up taxes on sugary drinks causing CPI to rise – I suppose neo-fisherians would say that nominal rates would fall, but that’s rather contradictory of the idea that central banks control the nominal rate which is implicit in the strong formulation of the claim. Perhaps it is simply a matter of framing – clearly both central banks and market forces can affect nominal interest rates, and there is not one nominal interest rate but many.

My point is not that the view is wrong – indeed I have cautiously espoused it for a while now. My points are twofold. Firstly, it’s become such a common belief as to no longer be a differentiating point to believe in the market. Secondly, it’s a partial and contingent belief – not a grand unifying theory of monetary affairs.




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