Whether Interest Rates are the Most Significant Drivers of Inflation

DOI

10.2991/978-94-6463-888-2_49How to use a DOI?

Keywords

Inflation; Interest Rate; Monetary Policy

Abstract

The effectiveness of interest rate policy in controlling inflation has long been a foundational assumption in macroeconomic theory and central banking for a long time. However, the relative importance of interest rates as compared to other macroeconomic variables remains an empirical question of debate, especially for the recent monetary regimes and inflation shocks. This paper aims to examine whether interest rates are the most significant factor influencing inflation, or whether other variables, namely money supply and real economic activity play a more important role. Using monthly panel data from two countries between January 2014 and November 2019, both single and multiple linear regression models are conducted to evaluate the impact of nominal interest rates, broad money supply (M2), and real GDP index on inflation. The results indicate that, although interest rates exhibit the expected negative relationship with inflation, money supply emerges as the most statistically and economically significant explanatory variable. The preferred model achieves an adjusted R² of 0.611, with all three variables contributing to explanatory power, but with money supply exerting the strongest marginal effect. These findings challenge the conventional emphasis on interest rate-centric policy regimes and suggest that a broader monetary framework, accounting for liquidity conditions and monetary aggregates, is essential for understanding and managing inflation dynamics. These results offer valuable insights for policymakers seeking to preserve price stability in dynamic economic environments.

Copyright

© 2025 The Author(s)

Open Access

Open Access This chapter is licensed under the terms of the Creative Commons Attribution-NonCommercial 4.0 International License (http://creativecommons.org/licenses/by-nc/4.0/), which permits any noncommercial use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license and indicate if changes were made.

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TY  - CONF
AU  - Weijia Jia
PY  - 2025
DA  - 2025/12/03
TI  - Whether Interest Rates are the Most Significant Drivers of Inflation
BT  - Proceedings of the 2025 7th International Conference on Economic Management and Cultural Industry (ICEMCI 2025)
PB  - Atlantis Press
SP  - 502
EP  - 510
SN  - 2352-5428
UR  - https://doi.org/10.2991/978-94-6463-888-2_49
DO  - 10.2991/978-94-6463-888-2_49
ID  - Jia2025
ER  -