BUFT Journal of Business and Economics

Assessing the relationship between inflation and policy interest rates in the context of Bangladesh

Finance Division, Ministry of Finance
Email: fardousalom.official@gmail.com

Abstract

Purpose: This study attempts to empirically assess the short and long-run relationship between inflation and policy interest rate in the context of Bangladesh. Methodology: Vector Error Correction Model (VECM) has been utilized using quarterly data over the first quarter of 2010 to second quarter of 2022. Findings: The empirical findings reveal that the inflation is inversely related to the changes in policy interest rates in the short and long-run indicating that any increase in policy interest rate leads to a decrease in inflation rate and vice versa. This finding is consistent with the conventional monetary policy theory. Practical Implications: The findings provide insights to the policymakers and practitioners suggesting that the policy rate remains as an effective monetary policy instrument to manage inflation. Originality/Value: This study adds to the existing limited literature of inverse relationship between inflation and central bank policy rate using most recent data set. The model used in this study has been rarely used in the previous literature. Research Limitations: The current study employs quantitative technique of bi-variate VECM which is prudent, however, further study may be conducted using multi-variate VECM.