As I look at different countries for evidence of the Fisher Effect, the thought occurred to look at China. Would the Fisher Effect be discernible since their central bank’s (PBoC) nominal rate is not at the ZLB? It is free to move anyway it chooses. But then one realizes that they hold their PBoC rate stable for years on end, which opens the door to observing the Fisher Effect directly.
Let’s first realize that there is concern in China that inflation is too low. Core inflation is currently reading at 1.6%, which is below their target of 3.5%. There is more to that story, but can the Fisher Effect help us understand what is going on there?
This post will gather the variables for the Fisher Effect equation…
Natural inflation rate = Projected PBoC benchmark rate – Natural real output growth
(charts from tradingeconomics.com)
China’s Benchmark PBoC rate
Their central bank rate has been between 6.0% and 6.6% since 1st quarter 2011…. 3 years already.
When the PBoC rate stops actively moving, the Fisher Effect steps in and inflation starts drifting toward its natural level. So do we see inflation heading toward a natural level, or what Paul Krugman might call its “Stall Speed� (source, page 13)
China’s Core Inflation
Well, let’s look at the behavior of inflation over these years of a stable PBoC rate.
After the crisis, inflation was rising and the PBoC raised their benchmark rate to slow it down. Eventually inflation backed down to 1.5% or so, and by July of 2012, the PBoC rate declined to the 6.0% that we still see today. Inflation has been fairly stable for 3 years since, yet still below target.
So does this stable inflation reflect the natural rate of inflation from the Fisher Effect? Well, once the PBoC rate is held constant, inflation will start to drift. If inflation drifts up, the natural inflation rate is above. If it drifts down, the natural inflation rate is below. If it doesn’t drift at all, the natural rate is matched to the PBoC rate.
