What Is The Relationship Between Interest Rates, Growth, And Inflation? | Seeking Alpha
The study shows that there is a negative relationship between inflation and output growth in . Figure 1 shows quarterly data on real GDP growth and inflation. In this paper the relationship between inflation and economic growth (GDP) in the GDP, in real terms, is measured in levels and seasonally adjusted with possibility that the relationship between inflation and output growth on what now happens to wages and inflation, compared to real GDP.
But what about nominal GDP growth? There does appear to be some information there, with a correlation of 0. Generally speaking, the higher the level of interest rates, the higher the level of nominal growth and vice versa. As you probably noticed in the chart above, though, swings in nominal GDP tend to be much larger than swings in interest rates. If we smooth out these changes in GDP over a 5-year period, the correlation between the two variables moves up to 0.
So there appears to be a strong relationship between the average nominal GDP over the past 5 years and the current level of interest rates. Because of varying changes in inflation, which may rise more detracting from real growth or less adding to real growth than the increase in nominal GDP. When we average inflation over a 5-year period, the correlation moves up to 0. High inflation can make investments less desirable, since it creates uncertainty for the future and it can also affect the balance of payments because exports become more expensive.
As a result, GDP is decreases further. So it appears that GDP is negatively related to inflation. However, there are studies indicating that there may also be a positive relationship.
The Phillips curve, for example, shows that high inflation is consistent with low rates of unemployment, implying that there is a positive impact on economic growth. The paper is organised as follows: Some of them are briefly discussed here.
Fischer showed that inflation and growth are negatively related. More specifically, he argues that growth, investments and productivity are negatively related to inflation and that capital accumulation and productivity growth are also negatively affected by budget deficits. Moreover, he states that some exceptional cases show that even though high growth is not necessarily associated with low inflation and small budget deficits, high rates of inflation are not consistent with permanent growth.
Barro examined data for almost countries for the period between and and found that the impact of inflation on growth and investment is significantly negative, given that a number of countries characteristics are constant. An average increase in inflation of ten per cent leads to a decrease of GDP and investment by 0. He also showed that even if inflation has a small impact on growth, this appears to be significant in the long run. Bruno and Easterly examined the relationship between inflation and economic growth and they found that this relationship exists only if there are high inflation rates.
To determine the high rates of inflation, they set a threshold of 40 per cent. Above this threshold, inflation has a temporally negative impact on growth, whereas below this threshold, they found no robust relationship. The decrease in growth is temporary because after a high inflation crisis, the economy quickly recovers to its previous level. Their results are robust after controlling for other factors such as external shocks. Obviously this contradicts the conclusion of the Philips Curve oriented theories and supports the prediction of Real Business Cycles model.
Hence, in this study, we will analyze the reason behind this correlation. We note that one early evidence has been provided by Ozbek and Ozlalewho estimate the output gap for Turkey with Extended Kalman Filter and then analyse the correlation between output gap and inflation.
They find a negative correlation between these variables and a negative correlation between lagged output gap and inflation. There are several studies on the relationship between output and real exchange rate in the Turkish economy. Berument and Pasaogullari show that these two variables are negatively related in Turkey.
They report that the response of output to a real devaluation is negative and permanent. An overvalued currency may increase output but simply because it entails a risk of a depreciation it may eventually result in substantial output losses. These authors also find that a one-standard deviation shock to the real exchange rate increases inflation and a one-standard deviation shock to inflation appreciates the currency.
One strong relation between exchange rate and inflation is provided by the exchange rate pass-through. Evidence for the importance of this mechanism in the Turkish economy has been provided by Leigh and Rossi who employ a recursive vector auto regression model to investigate the impact of exchange rate movements on prices.
They report that the impact of exchange rate movements on inflation is over after a year and is mostly felt in the first four months. The effect is more pronounced on the wholesale price index than the consumer price index. Their third important finding is that the impact is over in Turkey in a shorter time and stronger than in other key emerging markets.
Another study on Turkey has been undertaken by Mendoza who investigates inflation and output trade-off within the dynamics of nominal exchange rate and finds significant evidence that lags of the nominal exchange rate depreciation explain a big part of the inflation rate and volatility.
His results reconfirm the existence of causality from exchange rate to inflation and shows that nominal depreciations raise inflation.
Turkey is a small-open developing economy without heavy government regulations. Therefore, it is possible to observe the effects of financial market developments on economic performance.
What Is The Relationship Between Interest Rates, Growth, And Inflation?
Turkey has also suffered from high and volatile inflation without running into hyperinflation, along with high variability in real exchange rate and output growth for almost three decades.
This provides a unique environment to observe the interactions among certain macroeconomic variables. High volatility in output, inflation and real exchange rate for long periods play a magnifying role and allow us to avoid type II error; not rejecting the null hypothesis even if the null is false. In this study, we do not argue that increases in output do not lead to higher inflation, but we say that the evidence we examine shows a negative not a positive relationship between growth and inflation.
We analyze this relationship and assert that this negative association is due to a third variable effect, that of real exchange rate.
Until the adaptation of the Euro, the exchange rate basket consisted of 1. After the acceptance of the Euro by European countries the basket has been calculated with 0. The inflation rate is calculated as the first logarithmic difference of the GDP deflator and growth is calculated as the logarithmic difference of the real GDP. The analyses pertain to the Q2 period and all data are quarterly.
Data on the Turkish economy are available on the website of the Central Bank of Turkey http: Figure 1 shows quarterly data on real GDP growth and inflation. GDP data are seasonally adjusted. We observe that these two variables move in opposite directions.
Inflation reaches its peak in Q2 when Turkey suffered one of the biggest financial crises of its history. In this crisis period GDP fell dramatically.
Subsequently, fluctuations in both variables subside. A noticeable drop in inflation has occurred after the stabilisation program. However, this program has ended with two big financial crises. Inflation rose sharply while declines in output have reoccurred.
Inflation and Growth: Positive or Negative Relationship? - SciAlert Responsive Version
After the November and February crises, inflation tended to decelerate while output growth tended to accelerate. This tendency has become more pronounced after the reform program of Transition to Strong Economy launched in Since then Turkey has been simultaneously experiencing a steady increase in output with steady declines in inflation.
This has constituted one of the motivating factors of the present study.