Modeling the Fisher Effect with System Dynamics
Been busy building a model to show the Fisher Effect. The model uses System Dynamics, which takes interrelated variables through a time simulation. The model is described in the video above.
The main point is that the path of inflation described by the model matches the path of CPI (less food and energy) since the 1st quarter 2010 when CPI inflation hit its bottom. (See graph called “Inflation watch” in the video).
The model shows that as long as the Fed rate is proactive, it can drive inflation. Yet, when the Fed rate became s-trapped on the zero lower bound, the Fisher Effect became the more influential factor. If understood, the Fisher Effect offers a wonderful strategy for influencing inflation.
Just want to point out one thing not mentioned in the video. The graph for the “Fed Pulse & Fisher Effect” in the upper right corner needs a little more explanation. When the Fed pulse goes negative, inflation will rise, not fall. When the Fisher Effect goes negative, inflation will fall. I switched the Fed pulse like to better see when the two lines cross. The lines cross at the time period of 4 quarters in the video, the Fisher Effect becomes more influential upon the inflation rate than the Fed pulse. It is at that point that inflation hit its maximum in 2011 and started to fall.
System Dynamics is a wonderful tool to understand economics. It is surprising how little it seems to be used.
The Fisher effect doesn’t seem to have a great deal of influence outside the 1970s and 80s and even then only on longer term interest rates:
The effects that move interest rates
The Fisher effect
Lambert
it’s not surprising how little it is used. it’s hard.
and apparently complex enough to have a chance of meaning something.
and that might disagree with what the economists in question want to mean.
Jason,
I will post something tomorrow to shed more light on how the Fisher effect works in the long run. It all depends on the inflation potential of the economy and especially labor share/inequality.
Edward,
In case you haven’t seen them , here are links to two new articles by the St. Louis Fed that discuss the Fisher effect and the possibility that it may be responsible for the low inflation we’re seeing :
The Liquidity Trap: An Alternative Explanation for Today’s Low Inflation
http://www.stlouisfed.org/publications/re/articles/?id=2505
The Ups and Downs of Inflation and the Role of Fed Credibility
http://www.stlouisfed.org/publications/re/articles/?id=2502
Thanks Marko,
I have not seen them yet. I will check them out.