An Empirical Study of the Fisher Effect and the Dynamic Relationship between Inflation and Interest Rate in Sri Lanka

Navoda Edirisinghe (), Selliah Sivarajasingham () and John Nigel ()
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Navoda Edirisinghe: Assistant Lecturer, Department of Economics and Statistics, Faculty of Arts, University of Peradeniya, Sri Lanka,
Selliah Sivarajasingham: Senior Lecturer, Department of Economics and Statistics, Faculty of Arts, University of Peradeniya, Sri Lanka,
John Nigel: Senior Lecturer, Department of Economics and Statistics, Faculty of Arts, University of Peradeniya, Sri Lanka,

International Journal of Business and Social Research, 2015, vol. 5, issue 1, 47-62

Abstract: Maintaining price stability is one of the primary objectives of monetary policy in any economy as price instability, particularly high inflation, will cause to reduce economic growth by reducing investments and productivity growth. Therefore, investigating the existence of Fisher Effect and Price Puzzle is a necessary requirement in order to understand the nature, extent and dynamics of effective monetary policies in Sri Lanka. The main objective of this study is to investigate the existence of short run and long run Fisher Effect and Price Puzzle in Sri Lanka. The results from co-integration technique, Error Correction Model (ECM) which employed in the study suggest that in Sri Lanka, nominal interest rates fully adjust for expected inflation in long-run. But in short-run, a significant positive association between nominal interest rates and expected inflation is there with absence of full Fisher Effect. Moreover the analysis has been extended and identified the existence of the Price Puzzle both in a short run and long run. Therefore, changes in monetary instruments do not appear to be completely effective in meeting the goal of low inflation. In order to solve this problem what we can recommend is, Sri Lanka should move towards inflation-targeting monetary policy system.

Keywords: Cointegration; error correction model; Fishers effect; price puzzle; Sri Lanka. (search for similar items in EconPapers)
JEL-codes: E31 E42 E44 E52 E58 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (1)

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