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Interest rates, inflation, and exchange rates in fragile EMEs: A fresh look at the long-run interrelationships

Hüseyin Şen (), Ayşe Kaya, Savaş Kaptan and Metehan Cömert
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Hüseyin Şen: AYBU - Ankara Yıldırım Beyazıt University
Ayşe Kaya: Izmir Katip Celebi University
Savaş Kaptan: AYBU - Ankara Yıldırım Beyazıt University
Metehan Cömert: Izmir Katip Celebi University

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Abstract: This study attempts to establish the possible existence of the long-run interrelationship between interest rates, inflation, and exchange rates in five fragile emerging market economies (Brazil, India, Indonesia, South Africa, and Turkey), what is so-called by Morgan Stanley ‘Fragile Five'. To do so, we utilize Li and Lee's (2010) Autoregressive Distributed Lag (ADL) test for threshold cointegration and apply it to sample countries' monthly time-series data from 2013:1 to 2018:12. Overall, our primary results are threefold: First, there seems to be a long-run positive relationship between actual rates of inflation rates and nominal interest rates supporting the validity of the ex-post Fisher hypothesis for all the sample countries. Second, the sample countries' data supports the presence of a cointegration relationship between interest rates and exchange rates for the case of Brazil, India, and Turkey but not for the case of Indonesia and South Africa. Lastly, without exception, exchange rates and actual rates of inflation in all the sample countries examined tend to co-move in the long-run, implying that the depreciation of their currencies creates inflation through raising the prices of imported goods. The results above are widely compatible with both theoretical expectations and the results of the most previous empirical studies on the long-run interrelationships between interest rates, inflation, and exchange rates in the literature.

Keywords: Macroeconomic policy; autoregressive distributed lag; threshold cointegration; emerging market economies; macroeconomic policy management (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac, nep-mon and nep-sea
Date: 2019-05-17
Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-02095652v2
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