Non-stationarity and tax effects in the long-term Fisher hypothesis
The long-term Fisher hypothesis under rational expectations and constant ex ante real rates is tested using Danish data covering the post World War II period. The analysis takes into account that interest rates and inflation rates are non-stationary processes, integrated of order one. In addition, the issue of whether interest rates should be measured in pre-tax or after-tax terms is addressed. The results show strong support for the Fisher hypothesis once interest rates are stated in after-tax terms. The cross-equation restrictions implied by the hypothesis on a particular VAR model are not statistically rejected, and the long-term after-tax interest rate appears to be a very useful forward-looking predictor of future long-term inflation.