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.