Time Series Analysis of the Relationship Between Interest Rate and Private Investment in Turkey

The two major determinants of private fixed investment are per capita real gross domestic product and real interest rate. Income channel works through capital adjustment mechanism and the effects of changes in income on fixed investment depends on capital output ratio. Real interest rate, on the other hand, represents the alternative cost of investment. For almost a decade, private investment has been sluggish, and as a result, there has been a heated debate in both political and academic circles regarding the level of interest rate and whether low interest rate is a major stimulus for the private investment in Turkey. In this paper we model the interaction between real interest rate and private investment in Turkey over the period between 1973 and 2014. Our findings indicate that there is unidirectional causality from real interest rate to private investment in the short and long run. However, there are breaks in terms of the size of the relationship, trend and regime during the second oil crisis (1978), Asian and Russian economic crises (1887, 1999), and global financial crisis (2008/2008). Therefore, we conclude that there is room for the monetary policy to stimulate private investment by lowering real interest rate in Turkey.