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The effects of inflation uncertainty on interest rates: a nonlinear approach

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  • Tolga Omay
  • Mubariz Hasanov

Abstract

In this article, we investigate the effects of inflation variability on short-term interest rates within a nonlinear smooth transition regression framework. The test results suggest that only the conditional mean of the inflation is a nonlinear process whereas the conditional variance is time variant but linear. Using the square root of conditional variance as a proxy for inflation risk, we estimate Fisher equation augmented with inflation risk. Although the estimated Fisher equations suggest that inflation risk reduces short-term interest rates, we find that the effects of inflation risk on interest rates are regime-dependent. Particularly, we find that the negative effects of inflation variability on nominal rates are greater in low-inflationary regimes when compared to high-inflationary regimes. On the other hand, it is found that both inflation and inflation uncertainty raise the expected inflation effect.

Suggested Citation

  • Tolga Omay & Mubariz Hasanov, 2010. "The effects of inflation uncertainty on interest rates: a nonlinear approach," Applied Economics, Taylor & Francis Journals, vol. 42(23), pages 2941-2955.
    • Handle: RePEc:taf:applec:v:42:y:2010:i:23:p:2941-2955
    DOI: 10.1080/00036840801964757
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    References listed on IDEAS

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    1. Lundbergh, Stefan & Teräsvirta, Timo, 1998. "Modelling economic high-frequency time series with STAR-STGARCH models," SSE/EFI Working Paper Series in Economics and Finance 291, Stockholm School of Economics.
    2. Chan Guk Huh, 1996. "Regime switching in the dynamic relationship between the federal funds rate and innovations in nonborrowed reserves," International Finance Discussion Papers 536, Board of Governors of the Federal Reserve System (U.S.).
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    Cited by:

    1. Su Zhou, 2013. "Nonlinearity and stationarity of inflation rates: evidence from the euro-zone countries," Applied Economics, Taylor & Francis Journals, vol. 45(7), pages 849-856, March.
    2. Andrew Phiri, 2015. "Asymmetric cointegration and causality effects between financial development and economic growth in South Africa," Studies in Economics and Finance, Emerald Group Publishing Limited, vol. 32(4), pages 464-484, October.
    3. Tolga Omay, 2011. "The relationship between inflation, output growth, and their uncertainties: Nonlinear Multivariate GARCH-M evidence," Economics Bulletin, AccessEcon, vol. 31(4), pages 3006-3015.
    4. Tolga Omay & Reneé Eyden & Rangan Gupta, 2018. "Inflation–growth nexus: evidence from a pooled CCE multiple-regime panel smooth transition model," Empirical Economics, Springer, vol. 54(3), pages 913-944, May.
    5. Phiri, Andrew, 2015. "Examining asymmetric effects in the South African Philips curve: Evidence from logistic smooth transition regression (LSTR) models," MPRA Paper 64487, University Library of Munich, Germany.
    6. Omay, Tolga & Iren, Perihan, 2019. "Behavior of foreign investors in the Malaysian stock market in times of crisis: A nonlinear approach," Journal of Asian Economics, Elsevier, vol. 60(C), pages 85-100.
    7. Afsin Sahin & Volkan Ulke, 2015. "Farkli Belirsizlik Duzeylerinde Faiz Oraninin Makroekonomik Degiskenlere Etkileri : Turkiye Uzerine Etkilesimli Vektor Otoregresif Modeli Uygulamasi," Central Bank Review, Research and Monetary Policy Department, Central Bank of the Republic of Turkey, vol. 15(1), pages 65-93.
    8. Chen, Shyh-Wei & Hsu, Chi-Sheng, 2016. "Threshold, smooth transition and mean reversion in inflation: New evidence from European countries," Economic Modelling, Elsevier, vol. 53(C), pages 23-36.

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