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

Author

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  • Hüseyin Şen
  • Ayşe Kaya
  • Savaş Kaptan
  • Metehan Cömert

Abstract

This study attempts to establish the possible existence of the long-run interrelationship between interest rates, inflation, and exchange rates in five EMEs (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. “ADL Tests for Threshold Cointegration.” Journal of Time Series Analysis 31 (4): 241–254.] Autoregressive Distributed Lag test for threshold cointegration and apply it to the sample country's time-series data from 2013:m1 to 2018:m12. Overall, our results are threefold: First, there seems to be a long-run positive relationship between actual rates of inflation and nominal interest rates supporting the validity of the ex-post Fisher hypothesis for all the sample countries. Second, the results support the presence of a cointegrating relationship between interest rates and exchange rates for Brazil, India, and Turkey but not for Indonesia and South Africa. Lastly, without exception, exchange rates and actual rates of inflation in all the sample countries tend to co-move in the long-run, implying that the depreciation of their currencies creates an inflationary effect on domestic prices through raising the prices of imported goods. The results above are widely consistent with both theoretical expectations and the relevant empirical literature.

Suggested Citation

  • Hüseyin Şen & Ayşe Kaya & Savaş Kaptan & Metehan Cömert, 2020. "Interest rates, inflation, and exchange rates in fragile EMEs: A fresh look at the long-run interrelationships," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 29(3), pages 289-318, April.
    • Handle: RePEc:taf:jitecd:v:29:y:2020:i:3:p:289-318
    DOI: 10.1080/09638199.2019.1663441
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    Cited by:

    1. Hüseyin İlker Erçen & Hüseyin Özdeşer & Turgut Türsoy, 2022. "The Impact of Macroeconomic Sustainability on Exchange Rate: Hybrid Machine-Learning Approach," Sustainability, MDPI, vol. 14(9), pages 1-19, April.
    2. Emin Karataş & Ayyüce Memiş Karataş, 2023. "This research discusses the causal relationship among the exchange rates, 10-year bond yields, and Central Bank policy rates with regard to the countries known as the Fragile Five (F5) by comparing th," EKOIST Journal of Econometrics and Statistics, Istanbul University, Faculty of Economics, vol. 0(39), pages 65-75, December.
    3. Mehmet Ulug & Sayım Işık & Mehmet Mert, 2023. "The effectiveness of ultra-loose monetary policy in a high inflation economy: a time-varying causality analysis for Turkey," Economic Change and Restructuring, Springer, vol. 56(4), pages 2855-2887, August.
    4. Kartono, Agus & Febriyanti, Marina & Wahyudi, Setyanto Tri & Irmansyah,, 2020. "Predicting foreign currency exchange rates using the numerical solution of the incompressible Navier–Stokes equations," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 560(C).

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