Macroeconomic Variables That Influence the Determination of Interest Rate: Evidence from Sri Lanka

Abstract

The interest rate is one of the main tools used to governor monetary policy in Sri Lanka. The main objective of this research was identifying the Macroeconomic variables that Influence to determine the Interest Rate: Evidence from Sri Lanka. Changes in macroeconomic variables affect to determine interest rate. At present, there are some consensus on the answers to these questions. This paper examines to identify Macroeconomic variables that influence the determine the interest rate in Sri Lanka and identify the relationship between interest rate and macro-economic variables. The model of this study was estimated using quarterly data from 2004:Q1 to 2015:Q4. This study uses Macro-economic variables such as money supply, budget deficit, inflation, and economic growth. This study uses Average Weighted Prime Lending Rate (AWPR), and 3-month T bill rate as benchmark interest rates in Sri Lanka. Variables were initially tested for stationery and autocorrelation, and both inflation and budget deficit were found as non-stationary, the first difference of these variables was considered. There was no autocorrelation amongst any of the variables. Granger causality tests use for finding the interrelationships between the variables in the model. looking at the overall models, it was seen that both models was significantly represented by their F-values, only the first difference of inflation and real GDP were significant in both models. There was no direct causation of interest rates from changes in inflation and real GDP. It was observed that collectively both money supply and budget deficit had a significant impact on the level of interest rates. The R-squared values are in the range of 25%. The conclusion of the study is the explanatory variables are weakly affected to determining interest rates in Sri Lanka during the reference period. Further found that all the macro-economic variables showed a positive linear relationship with the T bill rate and AWPR in Sri Lanka.