Abstract
In today’s world where the independence of central banks is questioned and the recessionary process is discussed, serious debates are experienced between economists and policy makers regarding the paradoxical relationship between two important macro-economic variables; Is inflation the cause of interest rate or is interest rate the cause of inflation? Determination of the causality and its direction is very crucial for the economies which are trying to extricate themselves from the high inflation – high interest rate spiral. The researchers searching for an answer to these discussions have conducted various analyses to test the validity of the Fisher Effect. In these analyses, inflation rate and nominal interest rate -as per the hypothesis- were considered as the variables. However, economic agents make their decisions depending on real values rather than nominal values. The purpose of this study is to provide a real and up-to-date approach to these debates which actually began in 1700s and have been ongoing in the triangle of financial markets-central banks-policy makers. For this purpose, the monthly averages regarding the 2011:01-2019:06 period of Turkey were calculated based on the Weighted Average Cost of Funding (WACF) daily data of The Central Bank of the Republic of Turkey (CBRT) and subjected to the cointegration analyses with the annual CPI figures. While Engle-Granger Test was used to test the long-term relationship, Granger Causality Test was performed to determine the relationship and its direction in the short term through VECM. As a result of the analysis, bilateral causality among variables was determined in the short term. In other words, inflation is a cause of interest rate and interest rate is a cause of inflation. This study makes a contribution to the literature since no study, which detected a bilateral correlation, has been found.
Highlights
Inflation refers to a permanent and long-term increase in the price level
In today’s world where the independence of central banks is questioned and the recessionary process is discussed, serious debates are experienced between economists and policy makers regarding the paradoxical relationship between two important macro-economic variables; Is inflation the cause of interest rate or is interest rate the cause of inflation? Determination of the causality and its direction is very crucial for the economies which are trying to extricate themselves from the high inflation – high interest rate spiral
The purpose of this study is to provide a real and up-to-date approach to these debates which began in 1700s and have been ongoing in the triangle of financial markets-central banks-policy makers
Summary
Achieving price stability is important, and it constitutes the main objective of central banks today. Interest rate is a strong monetary policy instrument used by central banks against inflation; interest rate is the "time risk" of the money. Central banks shape their interest rates, asset prices, expectations and exchange rates by using the policy interest rates. Through policy interest rate decisions, central banks indirectly influence and even shape consumption and investment decisions as well as the price level. There are two types of interest rates used by the Central Bank to influence the interest rates shaping in the market;
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