Causal Relationship between Interest Rate and Inflation Rate: A study of SAARC Economies

Abstract

This article focuses on the evaluation of the causal relationship between interest rate and inflation rate in SAARC economies by using panel data ranging from the year 2006 to 2013. The need for this type of research from both dimension are very important. From one side according to macroeconomic issues, the increase in interest rate will lead to increase in the production costs and consequently the level of prices and inflation rate increases. On other hand theoretically it is expected that with increase in level of prices the interest rate will also increase. For the assessment of the causal relationship between interest rate and inflation rate, two scenarios have been identified; in the first scenario the causal relationship between lending interest rate and changes in inflation rate has been tested empirically and in second scenario causal relationship between real interest rate and inflation rate is considered. The obtained results in first scenario show that there is no relationship from changes in inflation rate to the changes in lending rate but in second scenario, the results are dual in nature showing the cause and effect relationship between real interest rate and inflation rate.