The Mundell-Tobin Effect

This article explains the Mundell-Tobin effect by showing the relationship between the ISLM and ADAS models. The Mundell-Tobin effect states that nominal interest rates may not rise 1:1 with price levels, as the Fisher effect states.

The Fisher effect derives from Fisher’s identity of i = r + π where i=nominal interest rates, r = real interest rates and π=inflation rate (i.e. rate of change in price levels). Fisher believed that if π rose by 1 then i must also rise by one.

Mundell-Tobin came along and said that this wasn’t the case, because they believed that r, the real interest rate, would fall if inflation rose, meaning the overall effect would be that i didn’t rise on a 1:1 basis with inflation. [...]