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The Cross-country Relationship between Interest Rates and Inflation over Three Decades

Author

Listed:
  • Michele Bullock

    (Reserve Bank of Australia)

  • Mark Rider

    (Reserve Bank of Australia)

Abstract

This paper looks at the relationship between inflation and interest rates across a number of industrialised countries over the past three decades. The paper is in three parts. It begins by splitting the whole period up into a number of smaller periods and looking at the inflation/interest rate relationship across countries within these periods. The most interesting conclusion of this section is that while there was a negative relationship between inflation and real short-term interest rates in the 1970s (i.e. high inflation countries had lower real short-term interest rates), in the 1980s there was a positive relationship between real short-term interest rates and inflation. The paper then discusses some explanations for this observation – why might we expect to see higher real interest rates in high inflation countries and why has this only occurred in the 1980s. Finally the paper uses a simple test to attempt to distinguish between competing explanations of the positive inflation/real interest rate relationship. Unfortunately, the test cannot distinguish conclusively between the competing hypotheses.

Suggested Citation

  • Michele Bullock & Mark Rider, 1991. "The Cross-country Relationship between Interest Rates and Inflation over Three Decades," RBA Research Discussion Papers rdp9104, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp9104
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    File URL: https://www.rba.gov.au/publications/rdp/1991/pdf/rdp9104.pdf
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    References listed on IDEAS

    as
    1. David W.R. Gruen, 1991. "The Effect of Steady Inflation on Interest Rates and the Real Exchange Rate in a World with Free Capital Flows," RBA Research Discussion Papers rdp9101, Reserve Bank of Australia.
    2. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    3. Darby, Michael R, 1975. "The Financial and Tax Effects of Monetary Policy on Interest Rates," Economic Inquiry, Western Economic Association International, vol. 13(2), pages 266-276, June.
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    Cited by:

    1. Anthony J. Richards, 1991. "The Cost of Equity Capital in Australia: What Can We Learn from International Equity Returns?," RBA Research Discussion Papers rdp9107, Reserve Bank of Australia.
    2. Sevda Yapraklı, 2022. "The Validity of The Neo-Fisher Effect in The Period of Explicit Inflation Targeting: An Econometric Analysis on Turkey," EKOIST Journal of Econometrics and Statistics, Istanbul University, Faculty of Economics, vol. 0(37), pages 85-105, December.
    3. K. M. Hawtrey, 1997. "The Fisher effect and Australian interest rates," Applied Financial Economics, Taylor & Francis Journals, vol. 7(4), pages 337-346.
    4. Nigel Dews & John Hawkins & Tracey Horton, 1992. "Measuring the Cost of Capital in Australia," RBA Research Discussion Papers rdp9205, Reserve Bank of Australia.

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