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 Hypothesis and Neo-Fisherian approach for Turkey by using Autoregressive Distributed Lag (ARDL) method developed by Pesaran et al. (2001) as well as the Granger causality test 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 October 2010-May 2020. Empirical results gathered from ARDL indicate that there is a positive and significant relationship between compound interest rate for government domestic debt securities (nominal interest rate), expected inflation rate and inflation uncertainty in the long run. The results of Toda and Yamamoto causality test suggest that inflation uncertainty and expected inflation affect nominal interest rates. Also, inflation uncertainty and expected inflation rate are affected by nominal interest rates. The empirical results indicating two-way causality provides significant empirical evidence for the presence of the Neo-Fisherian effect in addition to the Fisher Hypothesis in Turkey.