Paul Krugman wrote today the obvious criticism against the Fisher Effect. He completely based his criticism on monetary shocks, which is a short-sighted view. He is not thinking beyond the shocks.
“And we know what happens after a positive shock to policy interest rates: output and inflation both fall.”
Yes, that is obvious, but what I have been showing here with the System Dynamics model is that once the shock wears off, the Fisher Effect can passively appear.
Nick Rowe (via David Beckworth) used the same logic against the Fisher Effect. He uses 20 years of Canadian monetary policy to show that the Fisher Effect was not seen. Well, of course, when policy rates are able to create shocks to overcome the passive Fisher Effect, you will not openly see the Fisher Effect.
Look… if policy rates are able to create continual shocks, Yes, output and inflation both fall as a short run reaction. Thus, monetary policy could keep inflation constantly reacting within the short run period of policy shocks. But if you then de-activate policy rates taking away their power to create shocks (maybe because of a zero lower bound with large output gap scenario), then the shocks disappear and how does inflation respond then? Inflation responds to the passive Fisher Effect.
An analogy is like a feather falling. You can blow under the feather to keep it in the air. and you can even blow in such a way that it looks as though the feather is not falling at all. Yet, if you stop blowing, the feather will naturally fall.
Mr. Krugman solely bases his criticism of the Fisher Effect on policy rate shocks, yet now he needs to address the various situations where shocks from policy rates disappear. What would he expect to happen then? As I see it, in those situations, inflation will move according to the long run Fisher Effect.