The debate over whether the Fisher Effect is real has languished over the past year. It is hard to prove, and even I lost hope in it. However, I may have found the mechanism to make it work.
First, look at this graph of the net profit rate plotted with core inflation since 1958... (link to data)
The logic of the graph is based on a dynamic that a high net profit rate relieves firms from having to raise prices to maintain profits. On the left side of the graph, a low net profit rate makes it necessary for firms to raise prices. A sweet spot sits somewhere between the two extremes and allows a balanced expression of prices so that inflation rests at the Fed’s target of 2%.
A recently very high net profit rate of 9% led to a very low inflation rate according to the graph. Firms had little pressure to raise prices with such high net profit rates.
So the key would be to lower the net profit rate to a sweet spot of 3% to 6%. Then firms would have more reason in the aggregate to raise prices to net protect profit rates. Then the central tendency of core inflation would rise to 2% according to the graph.
How could we lower the net profit rate? Drum roll please... raise the Fed rate.
So raising the Fed rate while we are on the right side of the sweet spot would raise core inflation. If we were on the left side of the sweet spot, the economy would contract away to the left from the sweet spot as the net profit rate goes too low. So the Fisher Effect could only work properly (raising the Fed rate to raise inflation) if the net profit rate puts core inflation on the right side of the core inflation target.
The reason why the Fisher Effect has never been seen before is that the economy has really never been much on the right side of the sweet spot before. Net profit rate only topped 4% in 2003 and 2004 when it reached 6%. Since 2009, it has been over 8%!
So instead of calling for a 4% inflation target, it might be better for the Fed to shoot for a 4% target in the net profit rate.