The Relationship Between Real Interest Rates and Inflation Essay

7751 Words Oct 27th, 2012 32 Pages
The Relationship between Real Interest Rates and Inflation
Michał Brzoza-Brzezina*

Abstract In the recent decade, a huge amount of papers, describing monetary policy rules based on nominal interest rates, has been written. As it is, however, well known, it is in fact the real and not the nominal interest rate, that can influence spending decisions of enterprises and households and thus inflation. One way, to describe the relationship between real interest rates and inflation, is based on our experience with the monetary theory of the price level. The quantity theory of money can be used under certain assumptions as a good description of the long-run relationship between money and prices. In this respect the best known empirical
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ments are welcome: Michal.Brzoza-Brzezina@nbp.x400.net.pl

Contents
1 2 Introduction ........................................................................................................................3 The models .........................................................................................................................5 2.1 Model 1: interest rate gap as a determinant of inflation .................................................5 2.2 Model 2: interest rate gap as a determinant of inflation growth.....................................8 3 Empirical results ...............................................................................................................10 3.1 The data ........................................................................................................................10 3.2 Integration tests.............................................................................................................12 3.3 Cointegration tests - model 1........................................................................................13 3.4 Cointegration tests - model 2........................................................................................17 4 Conclusions ......................................................................................................................22 Appendix 1 ...............................................................................................................................24

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