Do interest rates predict real economic activity?

Abstract

This paper employs a structural VAR procedure to test some fundamental propositions of the business cycle using a developing economy framework. The focus of the paper is on KBC, MBC and RBC theories as well as on the alternative view, which has been propagated mainly by Sims. The empirical analysis intends to report extensive evidence on the dynamics between money, output, interest rates and prices. The results suggest that the effects of system shocks conform to the alternative view supporting the central role of interest rates. Interest rate shocks explain a majority of the variation in money, output and prices. The results are generally robust across different orderings, alternative interest rate measures and various sample periods.