Fisher Effect and the Relationship between Nominal Interest Rates and Inflation: The Case of Nigeria

This research study carries out empirical investigations of the Fisher effect and the long-run relationship between nominal interest rates and expected inflation in Nigeria making use of annual data covering a period of half of a century. Fisher (1930) postulation is that nominal interest rates should reflect the expected rate inflation rates movements on one-for-one basis. Applying the Nigerian data covering the period between 1961 and 2009, this study uses the 3-month treasury bill rates to proxy for nominal interest rates while the 12-month moving average headline inflation serves as the expected inflation. Apart from the descriptive analyses of the sample data, the econometric approaches which the study employs are the ordinary least square (OLS) regression, the Engle-Granger ADF residual-based cointegration, the Johansen maximal likelihood cointegration and Granger causality test. Testing the data, using the augmented Dickey-Fuller (ADF) unit root test method, it was found out that nominal interest rate and expected inflation were non-stationary in levels but in first differences. This suggests that the OLS regression may be spurious even as the result rejects a full fisher effect in Nigeria. The results of the cointegration tests imply that there is no long-run cointegration relationship between nominal interest rates and inflation in Nigeria. The Granger causality tests report that expected inflation does not Granger cause nominal interest rates in Nigeria, but a one-way directional movement running only from nominal interest rates to inflation. The problem of high inflation identified in the history of Nigeria prompted the recommendation for the adoption inflation targeting policy for the country and other countries in this category while the interest rate should be set in line with the dictates of the economy