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The effects of inflation uncertainty on interest rates: a nonlinear approach

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  • Tolga Omay
  • Mubariz Hasanov

Abstract

In this article, we investigate the effects of inflation variability on short-term interest rates within a nonlinear smooth transition regression framework. The test results suggest that only the conditional mean of the inflation is a nonlinear process whereas the conditional variance is time variant but linear. Using the square root of conditional variance as a proxy for inflation risk, we estimate Fisher equation augmented with inflation risk. Although the estimated Fisher equations suggest that inflation risk reduces short-term interest rates, we find that the effects of inflation risk on interest rates are regime-dependent. Particularly, we find that the negative effects of inflation variability on nominal rates are greater in low-inflationary regimes when compared to high-inflationary regimes. On the other hand, it is found that both inflation and inflation uncertainty raise the expected inflation effect.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Economics.

Volume (Year): 42 (2010)
Issue (Month): 23 ()
Pages: 2941-2955

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Handle: RePEc:taf:applec:v:42:y:2010:i:23:p:2941-2955

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Cited by:
  1. Phiri, Andrew, 2014. "Asymmetric co-integration and causality effects between financial development and economic growth in South Africa," MPRA Paper 53055, University Library of Munich, Germany.
  2. Tolga Omay, 2011. "The relationship between inflation, output growth, and their uncertainties: Nonlinear Multivariate GARCH-M evidence," Economics Bulletin, AccessEcon, vol. 31(4), pages 3006-3015.

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