Monetary and fiscal factors in nominal interest rate variations in Sri Lanka under a deregulated regime

Maitra, Biswajit Article Monetary and fiscal factors in nominal interest rate variations in Sri Lanka under a deregulated regime Financial Innovation Provided in Cooperation with: Springer Nature Suggested Citation: Maitra, Biswajit (2017) : Monetary and fiscal factors in nominal interest rate variations in Sri Lanka under a deregulated regime, Financial Innovation, ISSN 2199-4730, Springer, Heidelberg, Vol. 3, Iss. 23, pp. 1-17, https://doi.org/10.1186/s40854-017-0075-8 This Version is available at: https://hdl.handle.net/10419/176465 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. http://creativecommons.org/licenses/by/4.0/ RESEARCH Open Access Monetary and fiscal factors in nominal interest rate variations in Sri Lanka under a deregulated regime Biswajit Maitra Correspondence: [email protected] Department of Economics, University of Gour Banga, Malda, West Bengal, India Abstract Background: This paper examines the role of monetary and fiscal factors in interest rate variations in Sri Lanka under its deregulated regime of interest rates. In addition the paper also examines the role of monetary factors in the variation of interest rates, using a quarterly dataset for the post-global recession period, when the exchange rate is determined by market forces. Results: Empirical analysis uses a dataset of nominal interest rates, money growth, income growth, changes in nominal exchange rate, and budget deficit. From the methodological point of view the paper involves vector autoregression model and Wald tests of Granger causality, followed by impulse response analysis while stationarity and the order of integration of the selected variables are confirmed involving the augmented Dickey-Fuller and the Phillips-Perron unit-root tests. Results: The paper confirms that both monetary and fiscal factors have significant effects on the variations of interest rates. Money growth triggers an increase in interest rates, which supports the Fisher equation view, while income growth has a negative impact. Budget deficit causes a rise in interest rates, but the role of the exchange rate is found to be almost insignificant, probably due to including exchange rate series that cover both the pegged and market-based regimes of exchange rates. The second part of the analysis, using a quarterly dataset for the post-global recession period, further establishes the positive impact of M2 money growth and income growth on interest rates. In this case, exchange rate depreciation causes an increase in interest rates. Conclusions: The significant role of monetary and fiscal factors in interest rate variations implies it would be possible to manage interest rates through a judiciary management of monetary and fiscal policies. Keywords: Nominal interest rate, Money growth, Income growth, Exchange rate, Budget deficit, Vector autoregression JEL codes: E43, E12 Background Interest rates play a key role in the transmission of the monetary policy. Nevertheless, they also have a significant role in the execution of fiscal policy. Identifying their behavior thus helps accomplish the desired objective of these policies. Economic theory indicates Financia l Innovation © The Author(s). 2017 Open Access This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided 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. Maitra Financial Innovation (2017) 3:23 DOI 10.1186/s40854-017-0075-8 interest rate variations depend on monetary, fiscal, and some external factors. However, theoretical studies find mixed evidence on the relationship between the interest rate and its determinants. Empirical research often helps specify the exact relations for the concerned countries, which is useful in the formulation of monetary policies. Consequently, this paper identifies how nominal interest rate variations in Sri Lanka are related to the few monetary and fiscal factors described in the economics literature. In Sri Lanka, interest rate variations were extremely low until the early 1980s. At that time due to inward looking economic policies and direct regulations there was a little room for interest rates to vary. Moreover, at that time, the financial sector was not developed. However, Sri Lanka initiated a structural reform policy in 1977 and embarked on a number of initiatives to develop its financial sector. Interest rates were then deregulated. The flexible exchange rate regime replacing the pegged exchange rate in Sri Lanka was initiated in January 2001. The reform measures resulted in markedly improved financial sector performance, as demonstrated by the national the financial soundness indicators. Variations of interest rates in Sri Lanka under regulated and deregulated regimes are presented in the time plot of the 91-day treasury bills (TBs) rate shown in Fig. 1. The figure reflects the variations were very low until the early 1980s, but became spectacular afterwards. The relatively higher interest rates during 1988–1995 were perhaps due to the anti-inflationary policy stance of the period. Further, higher interest rate over the periods of Asian financial crisis of 1997–1998 and the global financial recession of 2007–2008 reflect the policy stance of the Central Bank of Sri Lanka (CBSL) for crisis recovery. Only few studies (Cooray 2002; Jayasinghe and Udayaseelan 2010; Amarasekara 2005) analyze the behavior of interest rates in Sri Lanka (details are presented in “Brief literature review”section). To the best of my knowledge, the determinants of interest rates in Sri Lanka are not hitherto identified. Consequently, this paper confirms the role of monetary and fiscal factors in the variations of nominal interest rates in Sri Lanka under the deregulated regime. Specifically, using an annual time series dataset, the paper examines the role of money growth, income growth, changes in nominal exchange rate, and budget deficit in the variations in nominal interest rates for 1983– 2015. Furthermore, based on a quarterly dataset of the post-global financial recession period, when the market-based exchange rate regime was initiated, the role of monetary factors in the variations of interest rates are also studied. 0 4 8 12 16 20 24 1961 1967 1973 1979 1985 1991 1997 2003 2009 2015 91-da y TB rate 182-da y TB rate 364-da y TB rate Fig. 1 Time plot of annual interest rates in Sri Lanka. Source: author’s representation of CBSL data Maitra Financial Innovation (2017) 3:23 Page 2 of 17 Notably, the period 1983–2015 witnessed a paradigm shift in the exchange rate regime—from a pegged to an independent float regime. Specifically, at the time of gaining its independence in 1948, a fixed exchange rate system was operative, with the Sri Lankan rupee being pegged to the Indian rupee. In 1950, the rupee became the standard of monetary value (and was fixed at 0.88 g of gold) and the exchange rate was Rs 13.33 for one British pound and Rs 4.77 per one US dollar. This system was again replaced by a dual exchange rate system in 1968. The dual exchange rate system was then replaced by a managed floating system in 1977. Under this system, the exchange rate was linked to a basket of currencies. The managed floating exchange rate system was finally replaced by an independent float regime on January 23, 2001. The CBSL took a landmark step towards liberalizing the foreign exchange market by allowing commercial banks to determine the exchange rate according to the market forces of currency demand and supply. However, the CBSL retained its power to intervene on the foreign exchange market when required. The efficacy of the monetary policy and its transmission through the interest rate channel depend largely on the exchange rate system. The Mundell-Fleming model (Fleming 1962; Mundell 1963) of open economy macroeconomics testifies that the monetary policy of a small open economy becomes effective when the economy adopts a flexible exchange rate system. Further, under the flexible exchange rate system, the foreign exchange market could play significant role in interest rate variations. In fact, the first part of this study, covering the period 1983–2015, includes both the pegged and independent float regimes of the exchange rate in Sri Lanka. To account for the impact of the change in the exchange rate regime on the relation among interest rates and the selected determinants over this period, a dummy variable is used. On the other hand, in the second part of the study, which covers the post-global financial recession period, the independent float regime of exchange rate has been operating. Therefore, the second part of the analysis excludes the global financial recession period for a number of reasons. During this recession, the monetary policies of numerous countries were deviated to a crisis management trail. Although the crisis impacted the national macroeconomic policies over short period, the stability of the financial system was not affected. Unlike some European countries, no banks in Sri Lanka collapsed. One of the important reasons for the minimal impact of the crisis is the capital account not being fully liberalized. However, some short-term foreign investments were withdrawn. The foreign funds invested in Sri Lankan Treasury bills and long-term bonds were also withdrawn. To rescue the economy from the impasse of the crisis, some policy measures were thus initiated, and the CBSL intervened on the foreign exchange market to prevent the depreciation of the national currency. The remainder of this paper is structured as follows. In the following section, ‘Theoretical background and a brief literature review’related to the variation and determination of interest rates are presented. The section ‘Methods’puts forward the variables, data, and methodology; followed by section ‘Results and discussions’.The paper ends with “Conclusions”. Maitra Financial Innovation (2017) 3:23 Page 3 of 17 Theoretical background and a brief literature review Among the monetary factors affecting interest rate, the money supply is regarded as a potential determinant, although economic literature proposes contradictory theoretical relationships between the money supply and interest rate. One of the conventional views is the liquidity effect view, which postulates a negative relation between money and interest rate. That is, an unexpected growth of money supply lowers interest rates (to maintain equilibrium on the money market), with a unidirectional causality running from money supply to the interest rate. Keynes (1936) explains a transmission mechanism through which the interest rate variations due to change in investment, output, and employment in an economy can be analyzed. Conversely, based on the Fisher equation (Fisher 1930), a positive relationship exists between money growth and interest rate. Specifically, the Fisher equation states that the nominal interest rate equals the real interest rate plus the expected rate of inflation. If the real interest rate remains fixed and the money supply increases continuously, the price level or inflation increase, which in turn also increases the expected inflation. A higher expected inflation eventually causes the nominal interest rate to increase as well. Therefore, if the Fisher equation is found valid, there may be a positive causal impact of money supply on the nominal interest rate. Friedman posits some limitations to the above theoretical propositions, arguing that the Keynesian explanation cannot explain the situations where interest rate displays a positive response to money supply growth. On the other hand, the negative sensitivity of the interest rate to money growth, often found empirically, cannot be explained by the Fisher equation. Therefore, Friedman reformulates the theory to explain both the positive and negative sensitivities of the interest rate caused by money supply variations. He hypothesized that a fall or rise in interest rates depends on the relative growth of the money supply and anticipated nominal income, such that interest rates rise over time when the money supply growth rate increased provided this latter rate exceeds anticipated growth rate of nominal income. Conversely, interest rates fall due to money growth when the rate of money supply growth is below the anticipated nominal income growth rate. In fact, if the money supply is equal to the nominal income rate, the interest rate remains unchanged. A more detailed explanation of this theoretical proposition, as well as an empirical verification, can be found in Maitra (2017). Economic literature also holds the view that interest variations are positively related to the income level of the economy. Specifically, a higher national income or income growth causes a rise in the demand for money, which leads the interest rate to rise. Further, in a flexible exchange rate system, interest rate variations are related to capital flows and exchange rate movements. A decrease in the exchange rate usually lowers the demand for domestic financial assets and discourages foreign investors to invest in an economy. Therefore, the continuous depreciation of a currency may reduce foreign investment. A fall in foreign investment means a fall in the supply of funds which, as a consequence, increases the interest rate. Furthermore, the relationship between interest and expected exchange rates is analyzed by the uncovered interest rate parity (UIP) theory, where the domestic interest rate equals the foreign interest rate plus the increase in the expected value of the foreign currency. UIP theory shows that expected currency depreciation may cause the domestic interest rate to rise. Nevertheless, in an open economy, external factors such as the foreign interest rate and price levels may Maitra Financial Innovation (2017) 3:23 Page 4 of 17 influence the domestic interest rate, where the exchange rate transmits these external impulses to the domestic economy. Therefore, the exchange rate is an important determinant of the interest rate, particularly in a financially integrated open economy. On the other hand, interest rate variations also depend on fiscal policy instruments such as public debt, budget deficit, or fiscal deficit. There is a controversy among economists whether deficit increases the interest rate. Keynesian theory (Keynes 1936) posits that changes in budget deficit influence the interest rates. Specifically, an increase in the budget deficit or public debt causes the interest rate to rise. However, some economists argue that the expected budget deficit or government debt, instead of the present, affects the real long-term interest rate (Kameda 2014; Laubach 2009; Engen and Hubbard 2004; Quigley and Porter-Hudak 1994; Thorbecke 1993; Wachtel and Young 1987; Feldstein 1986). Conversely, the Ricardian equivalence argues that deficit does not matter. Moreover, the empirical research by Plosser (1982, 1987) and Evans (1987) fail to establish any significant positive relationship between budget deficits on the long-term interest rate. Therefore, the question whether budget deficits affect the interest rate is still inconclusive. Aisen and Hauner (2008) suggest the effect of budget deficits on the interest rate depends on several factors such as the degrees of capital mobility, of domestic or external financing for deficits, of interest rates being market determined. Among the few studies on this issue in Sri Lanka, Cooray (2002) studies whether the Fisher effectis valid. Using annual time series, the study finds evidences for the Fisher effect. Jayasinghe and Udayaseelan (2010) further examine the Fisher hypothesis in Sri Lanka involving annual, quarterly, and monthly time series for 1978–2007. However, the study fails to produce any evidence supporting the Fisher equation. Amarasekara (2005) studies the interest rate pass-through in Sri Lanka using daily datasets, including the repo, reverse repo, repo auction, and the money rates. The study also examines the size and speed of the pass-through from policy to call money market rates and that from the call money to commercial bank retail interest rates. The main findings are that the CBSL policy decisions are efficiently transmitted to the short end of the money market within days. The pass-through from policy rates to the call money rate is almost complete, but that from the call money rate to both lending rates and deposit rates of commercial banks is sluggish and incomplete. Further, no evidence of asymmetry in the passthrough over the different phases of the interest rate cycle is found. Moreover, few studies (Maitra and Debnath 2015; Amarasekara 2008) report that interest rate variations in Sri Lanka have significant impact on macroeconomic variables such as income and price level, suggesting the monetary policy is effective. Several studies address the determinants of interest rates in Asian countries, such as Maitra (2017), Abubakar and Sivagnanam (2016), Bhattacharya et al. (2008), Bhanumurthy and Agarwal (2003), Dua and Pandit (2002), Nachane (1988), and Paul (1984) for the Indian economy. These studies differ significantly regarding time span, data frequencies, modeling, and methodological aspects, their findings being thus mixed but generating significant discussions due to policy implications. On the other hand, Goh and Alias (2002) and Ahmad and Karim (2011) study the determinants of interest rates in Malaysia, Ahn (1994) focuses on Korea and Singapore, while He et al. (2014) study interest rate determination in China. Maitra Financial Innovation (2017) 3:23 Page 5 of 17 Apart from studies on Asian countries, a substantial volume of research examines the determinants of interest rates for many other developed and developing countries. Among these studies, Asamoah and Adu (2016) identify the determinants of the bank lending rate in Ghana for 1970–2013. Their empirical analysis confirms a long-run equilibrium relationship among the average lending rate charged by commercial banks and nominal money supply, income, price level, government fiscal balance, and exchange rate. Based on the estimated autoregressive distributed lag (ARDL), fully-modified ordinary least squares, and dynamic ordinary least squares models, the nominal exchange and monetary policy rates are shown tohave significant contemporaneous effects on the lending interest rate. Aksoy and León-Ledesma (2005) examine the long-term relationships between monetary policy indicators and real output in the U.S. and the U.K., but find no evidence of such relationships, nor a significant or stable long-term relationship between short term interest rates and real output for the sub-samples. Edwards and Khan (1985) present a model for determining the interest rate in developing countries. The empirical validity of this model is studied using dataset for Colombia and Singapore. They report that, in Colombia, both foreign and domestic factors affect nominal interest rates, while domestic interest rates in Singapore are fully determined by the foreign interest rates and exchange rate relationship between money supply and interest rates in 19 developed and 13 developing countries is studied by Monnet and Weber (2001). They find evidence of both the liquidity effect and support for the Fisher equation. Moreover, Turtelboom (1991) studies the determinants of interest rates for some African countries, while Howe and Pigott (1991) identify the determinants of long-term interest rates for several industrial countries. The determination of real interest rates in the European countries over the period 1959–1990 is studied by Knot (1995), while Akhtar (1995) presents a survey of empirical studies on the effects of monetary policy on long-term interest rates. Additionally, Caporale and Pittis (1997) develop a theoretical model and analyze interest rate determination in the United States, Japan, Germany, France, and Switzerland, finding that the behavior of interest rates reflects both internal and external influences in all five countries. Estimating a structural vector autoregression (VAR) model, Bernanke and Mihov (1998) enquire whether the liquidity effect view and longrun monetary neutrality are consistent in a model of the market for bank reserves under Fed’s operative regime. They find evidence for rejecting either the liquidity effect or long-run neutrality. Schabert (2005) analyzes the relation between interest rate targets and money supply in the rational expectations equilibrium of a standard cashin-advance model. The study reports that an accommodating money supply tends to destabilize equilibrium sequences if the interest rate target rule is forward-looking and active. Conversely, a sufficiently inertial interest rate target can be implemented by stabilizing the money supply policy. Methods Variables, data, and methodology The empirical analysis in this paper involves annual and quarterly time series datasets. The dataset of annual time series includes interest rates on 91and 364-day TBs as Maitra Financial Innovation (2017) 3:23 Page 6 of 17 measure of the nominal interest rate. Money growth (both M1 and M2), real gross domestic product (GDP) growth (as measure of income growth), and changes of the nominal exchange rate of the Sri Lankan rupee/US dollar are used as the monetary determinants of the interest rate. Budget deficit as a percentage of GDP is used as the fiscal determinant, while a dummy variable Dt examines the impact of change in the exchange rate regime on the relation to be studied; its value is 0 for the fixed exchange rate regime and 1 for flexible regime. The annual dataset covers 1983–2015, although the time span of 364-day TBs is 1989–2015. On the other hand, the quarterly dataset includes the call money rate and interest rates on 364-day TBs, deseasonalized quarterly real GDP growth, deseasonalized real M1, M2 money supply growth, and quarterly change in nominal exchange rate over the post-global recession period (2009:Q1–2016:Q2). Quarterly series of budget deficits or any other suitable series for fiscal determinants are not available and, therefore, the analysis using the quarterly dataset is limited to monetary factors. The symbolic representation of variables is presented in Table 1. The time series properties, namely the stationary and order of integration of the selected variables, need to be confirmed before selecting an appropriate econometric model for analysis. Among the various tests developed for studying stationarity and the order of integration, this study chose the augmented Dickey and Fuller (1981, henceforth ADF) and Phillips and Perron (1988, henceforth PP) unit-root tests. In the event of stationarity of selected variables at the level, underlying dynamics of interest rates with money growth, income growth, changes in exchange rate, and budget deficit have been studied by estimating an unrestricted vector autoregression (VAR) model. The causal impact of selected monetary and fiscal determinants on interest rates from the VAR model has further been studied using the Wald test of Granger causality. Further, impulse response analysis is used to access the dynamic movements of interest rates due to each of the endogenous innovations in the VAR. A more detailed technical account of these popular methodologies is not presented in this applied research due to space consideration. Table 1 Variables and representation Variables Specification Representation nominal interest rate annual rate of interest on 91-day TBs i a1t annual rate of interest on 364-day TBs i a2t quarterly series of call money rate i q1t quarterly series of interest on 364-day TBs i q2t budget deficit budget deficit as the percentage of GDP B t money supply growth annual series of real M1 money supply growth M 1at annual series of real M2 money supply growth M 2at quarterly series of real M1 money growth M 1qt quarterly series of real M2 money growth M 2qt rate of change of exchange rate rate of change of annual exchange rate E at rate of change of quarterly exchange rate E qt real income growth growth of annual real GDP at factor cost Y at growth of quarterly real GDP at factor cost Y qt Source: Author’s representation Maitra Financial Innovation (2017) 3:23 Page 7 of 17 However, the estimable form of the VAR model using interest rate, selected monetary, and fiscal determinants is presented below: 1a1t ¼α1þXn i¼1β1iia1t−iþXn i¼1θ1iMat−iþXn i¼1ρ1iEat−iþXn i¼1γ1iYat−i þXn i¼1δ1iBt−iþDtþε1t ð1Þ Mat ¼α2þXn i¼1β2iMat−iþXn i¼1θ2iia1t−iþXn i¼1ρ2iEat−iþXn i¼1γ2iYat−i þXn i¼1δ2iBt−iþDtþε2t ð2Þ Eat ¼α3þXn i¼1β3iEat−iþXn i¼1θ3iYat−iþXn i¼1ρ3iia1t−iþXn i¼1γ3iMat−i þXn i¼1δ3iBt−iþDtþε3t ð3Þ Yat ¼α4þXn i¼1β4iYat−iþXn i¼1θ4iia1t−iþXn i¼1ρ4iMat−iþXn i¼1γ4iEat−i þXn i¼1δ4iBt−iþDtþε4t ð4Þ Bt¼α5þXn i¼1β5iBt−iþXn i¼1θ5iia1t−iþXn i¼1ρ5iMat−iþXn i¼1γ5iEat−i þXn i¼1δ5iYat−iþDtþε5t ð5Þ where i a1t −i ,M a1t −i ,E at −i ,Y at −i ,andB t−i (i=1,2,…, n ) are lagged series of i a1t ,M a1t , E at ,Y at ,andB t series respectively. The optimum lag length, n , can be determined by the lag selection criterion, while ε 1t ,ε 2t ,ε 3t ,ε 4t ,andε 5t represent innovations that may be contemporaneously correlated but are uncorrelated with their own lagged terms and with all right-hand-side variables. Results and discussion The empirical analysis first studies the stationarity and order of integration of the selected series. The calculated values of the ADF and the PP unit-root tests are presented in Table 2, both test statistics failing to accept the null hypothesis of unit-root in each of the selected variables, even under annual and quarterly frequencies (with the appropriate assumption “intercept but no trend”). This means these series are stationary at level or I(0) stationary. As each of the selected variables are I(0) stationary, an appropriate model for identifying the role of monetary and fiscal determinants in the interest rate variations would be the VAR model. As stated in the previous section, I estimate the VAR model separately for two annual interest rates, first with M1money growth, income growth, change Table 2 Results of unit-root tests Annual Series ADF Statistic PP Statistic Quarterly Series ADF Statistic PP Statistic i a1t −3.125 (0.04) −3.793 (0.02) i q1t −4.653 (0.00) −3.923 (0.00) i a2t −4.421 (0.00) −4.816 (0.00) i q2t −3.168 (0.03) −3.548 (0.01) B t −4.009 (0.00) −4.745 (0.00) M 1qt −4.267 (0.00) −4.226 (0.00) M 1at −4.914 (0.00) −4.944 (0.00) M 2at −6.157 (0.00) −6.413 (0.00) M 2at −4.858 (0.00) −7.579 (0.00) E qt −3.460 (0.01) −3.126 (0.03) E at −5.144 (0.00) −5.143 (0.00) Y qt −4.408 (0.00) −5.523 (0.00) Y at −6.668 (0.00) −6.661 (0.00) Both ADF and PP tests have been conducted with the assumption “intercept but no trend”for the entire series. Values in parentheses indicate the probability of rejecting the null hypothesis on the unit root Source: Author’s estimation Maitra Financial Innovation (2017) 3:23 Page 8 of 17 impulse response analysis is used to trace the dynamic impact of interest rates due to the endogenous innovations of monetary and fiscal factors. The paper finds that, among the selected determinants, both M1 and M2 money growth cause interest rates to rise, supporting the Fisher equation view. On the other hand, the impact of income growth is negative, which is consistent with the positive impact of money growth on interest rates. The budget deficit causes interest rates to rise, which supports the Keynesian view. However, the role of the exchange rate on interest rate variations is almost insignificant and contradictory. This insignificant impact of exchange rate on interest rates reflects the overall impact of the two different exchange rate regimes in Sri Lanka over the analyzed period. This is also supported by the statistically significant estimate of the dummy variable, indicating that the change in exchange rate regime affects the relation that interest rates have maintained with monetary and fiscal factors. Moreover, over the post-global recession period, the positive causal role of broad money growth on interest rates is re-established. Further, a significant impact of income growth is also found. Furthermore, a prominent role of exchange rate on interest rate is established where exchange rate depreciation in the flexible regime causes an increase in interest rates. Therefore, the exchange rate affects interest rates significantly when a flexible exchange rate system is introduced. This paper has certain policy implications. As the interest rate is influenced by both monetary and fiscal factors, it would be effective to manage the interest rate through judicious monetary and the fiscal policy management. The significant effect of the exchange rate on interest rate during the post-global recession period (when the flexible -.04 .00 .04 .08 2 4 6 8 10 12 14 16 18 20 -.04 .00 .04 .08 2 4 6 8 10 12 14 16 18 20 -.04 .00 .04 .08 2 4 6 8 10 12 14 16 18 20 -.04 .00 .04 .08 2 4 6 8 10 12 14 16 18 20 ab cd Fig. 4 Response to Cholesky to one SD Innovation (±2 S. E. ). aResponse of call rate to call rate. b Response of call rate to M2 money growth. cResponse of call rate to income growth. dResponse of call rate to exchange rate change. Source: author’s estimation Maitra Financial Innovation (2017) 3:23 Page 15 of 17 exchange rate system was operational) suggests that, apart from the domestic factors, some external factors (typically transmitted through the exchange rate channel) could play a role in the variation of interest rates. However, further analysis is required in this direction. Another limitation of the paper is the short time span of the analysis. However, the reliability of estimations is verified with the limited degrees of freedom. Nevertheless, a study of the structural change in the dynamics of interest rates due to the monetary and fiscal determinants may provide further insights as a future research topic. Acknowledgements Author would like to thank the anonymous Reviewers of the journal for their comments on paper. Some of the comments help to improve the paper. Funding The author has received no funding for this research. Authors’information The author is an Assistant Professor at the Department of Economics, University of Gour Banga, West Bengal, India. Competing interests The author declares that he has no competing interests. Received: 22 April 2017 Accepted: 20 October 2017 References Abubakar J, Sivagnanam KJ (2016) Fisher’s effect: an empirical examination using India’s time series data. 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