Can raising interest rate reduce inflation or increase inflation?
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| Title | Can raising interest rate reduce inflation or increase inflation?
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| Author | Jiang Chun，Zhao Qiurong and Chen Yong |
| Organization | School of Economics and Management, Wuhan University |
| Email | jiachun@whu.edu.cn；whuemsqz@foxmail.com；chen.yongjd@163.com |
| Key Words | Whether raising interest rates increases inflation or curbs inflation is a big issue not only in theory but also in reality. Clarifying the relationship between interest rates and inflation will carry forward the interest rate liberalization and policy making. After verifying the instability of VAR model, this article uses LR static based on residual modification and rolling Granger causality test to explore the relationship between interest rates and inflation using monthly data from 1996-2013. |
| Abstract | Whether raising interest rates increases inflation or curbs inflation is a big issue not only in theory but also in reality. Clarifying the relationship between interest rates and inflation will carry forward the interest rate liberalization and policy making. After verifying the instability of VAR model, this article uses LR static based on residual modification and rolling Granger causality test to explore the relationship between interest rates and inflation using monthly data from 1996-2013. The paper found out that China’s interest rate is Granger cause of inflation and they keep negative relationship during most of the sample period except the period influenced by the global financial crisis, that is, raising interest rates can bring down the inflation, indicating the demand-side effects is dominating. The average negative impact of interest rate on inflation is only about -0.1% while the positive coefficient is 0.18%, implying that the reduction influence of interest rate on inflation is not strong and the supply-side effect (cost channel effect) is relatively more significant than demand-side effect when there is an economic downturn or foreign economic recession shock. It should be noted that the relationship between interest rates and inflation presented above is formed under the exiting system of China and the future relationship depends on China's further economic and financial reforms. |
| Serial Number | WP696 |
| Time | 2014-09-11 |
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