When does inflation lead or follow interest rates? Regime dependent evidence from Turkey

Metin Tetik and Görkem Kara
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Metin Tetik: Uşak University, Uşak, Turkey
Görkem Kara: independent researcher, Istanbul, Turkey

Applied Econometrics, 2026, vol. 83, 73-91

Abstract: This study investigates when inflation leads interest rates and when the opposite holds in Turkey over the period 1987–2023, employing rolling-window Granger causality tests combined with Markov-switching regime identification. We document that the direction of predictive causality is not constant but varies systematically across inflation regimes. In the 1994–2002 high-inflation episode, inflation predominantly Granger-causes interest rates, reflecting reactive monetary policy responses to price pressures and external shocks; this pattern aligns with conventional policy frameworks in which central banks raise rates in response to observed inflation. In the post-2021 high-inflation episode, by contrast, this direction reverses—interest rates predominantly Granger-cause inflation—indicating that causality direction is conditional on the prevailing policy regime rather than on the inflation level itself . Conversely, in low-inflation periods (primarily during 2002–2008, with a secondary episode during the 2018–2021 transition), interest rates Granger-cause inflation, consistent with forward-looking expectation channels when policy credibility is relatively higher. This reversal highlights the role of policy signaling and credibility in stable regimes. A notable absence of causality during 2009–2017 reflects external disturbances and policy uncertainty that decoupled these standard macroeconomic linkages. These findings underscore the limitations of time-invariant models in volatile emerging markets and demonstrate the utility of regime-specific econometric approaches. The results have direct implications for monetary policy design in Turkey and similar emerging economies, where structural volatility, exchange rate pass-through, and credibility constraints alter standard interest rate-inflation dynamics.

Keywords: inflation regimes; interest rates; Granger causality; rolling-window analysis; Markov-switching models; emerging markets; monetary policy (search for similar items in EconPapers)
JEL-codes: C22 E31 E43 (search for similar items in EconPapers)
Date: 2026
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