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Is Interest Rate an Effective Instrument for Controlling Inflation and Its Effect on Investment Activities in Developing Countries?

In: Corporate Management Ecosystem in Emerging Economies

Author

Listed:
  • Nor Isma Liyana binti Hasran

    (Universiti Malaysia Terengganu)

  • Jumadil Saputra

    (Universiti Malaysia Terengganu)

  • Adnan ul Haque

    (Yorkville University)

Abstract

Interest rates are often related to inflation, as extant literature on theory and policy indicates that interest rate is an instrument to control inflation. Rising price levels are also associated with weaker investor confidence. As in the IS–LM (investment–saving and liquidity preference–money supply) model, John Hicks explained that it is a two-dimensional macroeconomic tool that shows the relationship between interest rates and the assets market. However, there is a debate among researchers about whether interest rate (IR) is an effective instrument to control inflation (INFL) in developing countries. This debate is parallel to this research and aims to test the effectiveness of interest rates to control inflation in 20 selected developing countries. The research question is whether interest rate has a moderating or mediating effect to foreign direct investment (FDI). This study uses panel data from 20 developing countries (Bangladesh, Brunei, Chile, China, Colombia, India, Indonesia, Jordan, Laos, Malaysia, Maldives, Mongolia, Myanmar, Nigeria, Pakistan, Philippines, Singapore, Sri Lanka, Thailand, and Vietnam) from 1991 until 2021. We analyse inflation (INFL), interest rate (IR), money supply (MS), exchange rate (EXC), and foreign direct investment (FDI) using panel data regression. The result indicates that the fixed-effect model is the best model. Further, money supply (MS) and exchange rate (EXC) have a significant positive relationship with foreign direct investment (FDI). Meanwhile, interest rate (IR) has no significant relationship with foreign direct investment (FDI). We also found that Nigeria coefficient of money supply (MS) and exchange rate (EXC) are higher and more efficient than in another 19 selected developing countries. In conclusion, the main variables that affect foreign direct investment were money supply (MS) and exchange rate (EXC) while the interest rate (IR) is just mediating effect to foreign direct investment (FDI).

Suggested Citation

  • Nor Isma Liyana binti Hasran & Jumadil Saputra & Adnan ul Haque, 2023. "Is Interest Rate an Effective Instrument for Controlling Inflation and Its Effect on Investment Activities in Developing Countries?," Springer Books, in: Fred A. Yamoah & Adnan ul Haque (ed.), Corporate Management Ecosystem in Emerging Economies, pages 367-401, Springer.
    • Handle: RePEc:spr:sprchp:978-3-031-41578-4_20
    DOI: 10.1007/978-3-031-41578-4_20
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