The Fisher Effect would say that steady and low nominal interests would bring down inflation as the real interest rises to its natural level at full employment. OK… nominal interest rates are steady and low and inflation is low. So is it really the Fisher Effect that is bringing down inflation?

Just yesterday I posted that last year my model of the Fisher Effect predicted that inflation would stay low. Now… did inflation stay low due to the Fisher Effect or some other force?

The Fisher Effect should kick in when monetary policy has its hands tied for a long time. Even though we have seen the Fed rate stuck at the zero lower bound for many years, monetary policy has still been tightening because the Fed first stopped QE, then lately they have been saying that they will raise the Fed rate by the end of the year. Expectations of tightening ensued which tightened monetary policy even though the Fed rate and monetary base had not changed.

What about supply and demand in the aggregate economy?

Low interest rates globally are encouraging production on the supply side.

Lower labor share in the US, China and other advanced countries is reducing the consumer demand side. There isn’t strong fiscal policy demand since many other countries are limiting their fiscal spending. China has a strong fiscal stimulus policy but their strong financial repression measures keep inflation low.

So when supply is being boosted and demand is being weakened, prices should want to come down.

The point here is that these dynamics of supply and demand are only indirectly related to the Fisher Effect. The low interest rate could generate inflation if consumer and fiscal demands were increased. But labor share is not rising much, and the US govt debt is falling as a share of GDP. Low labor share and fiscal restraint are not caused by low nominal interest rates. So the dynamics of supply and demand are only indirectly related to any Fisher Effect.