Interest Rates: The Cause or The Result? A Chicken and Egg Problem Revisited (The Relationship between Interest Rates and Inflation in Turkey)

Abstract

This paper investigates the validity of Fisher’s hypothesis and neo-Fisherian approach for Turkey using cointegration of Pesaran et al. (2001) as well as the methodology of Granger causality developed by Toda and Yamamoto (1995). The scope of the study focuses on flexible inflation targeting period in Turkey. Inflation uncertainty is estimated by employing the GARCH model for the period 2010:M10-2020:M5. Empirical results indicate that there is a positive and significant relationship between nominal interest rates, expected inflation and inflation uncertainty in the long run. The results of Toda and Yamamoto causality suggests that inflation ucertainty and expected inflation effects nominal interest rates. Also inflation is affected by nominal interest rates. The empirical results indicating two way causality provides significant empirical evidence for the presence of the Neo- Fisher effect in addition to the Fisher’s hypothesis during the flexible inflation targeting period analyzed in Turkey.