To Test the Relationship between Interest Rate and Inflation Rate: The Case of Turkey (1980-2018)

Interest, which is defined as the rent of money, brings important discussions. According to the Keynesian approach, the interest rate is determined by money supply and money demand. While the money supply is constant, the increase in the demand for money raises the interest rate. At the same time, the decrease in the money supply while the demand for money is constant causes the interest rate to rise. Increasing interest rates have direct and indirect effects on macroeconomic variables. Changes in macroeconomic indicators also determine social balances. Therefore, increases or decreases in interest rates have significant results on social as well as economic indicators. As a matter of fact, the increase in interest rates leads to a decrease in production and an increase in unemployment in the long term. Unemployment causes the income distribution to deteriorate. On the other hand, high interest rates disrupt the budget balance. Monetization of budget deficits is the major cause of inflation. High inflation and interest rates are a problem for all economies. High inflation disrupts the distribution of resources by increasing risks and uncertainties and damages growth performance. Therefore, the main objective for central banks; to ensure the price stability. On the other hand, high interest rates also damage resource allocation and affect investments negatively. In this study, the relationship between inflation and interest rates were investigated for the period of 1980-2018 using time series analysis for Turkish economy. According to the cointegration test, interest and inflation variables act together in the long term. Impulse-response functions showed that the rise in inflation increased interest rates while the increase in interest rates decreased inflation. Therefore, monetary and fiscal policies should be implemented in coordination for economic stability.