This paper analyzes the Fisher effect and tests the validity of the Fisher hypothesis in China. Taking into consideration the short run dynamics of interest rates, we examine the Fisherian link in China by assessing the long run relationship between nominal interest rates (deposit rates) and inflation rates. In doing so, we apply the methodology, paying attention to the unit root and cointegration properties of the variables, since the meaningful Fisher effect critically depends on those properties. The empirical results indicate that the nominal rate of interest in China was nonstationary during the years 1993-2005 and unit root nonstationarity is rejected for this period as well. We find there is one long-term cointegration relationship between inflation and interest rates but is not significant. All the coefficients are significantly different from zero but all are different from one. This supported the argument that the policy experiments in China has less inflation targeting and active monetary policy, but stronger targeting economic growth, job creation and financial stability.
