Does a Monetary Tightening Rise or Lower Interest Rates? Case Study-Albania

Abstract

The purpose of this master thesis is to test the relationship between monetary policy and nominal interest rate, in case of monetary tightening for Albania in long and short run. To understand this link, the study is focused on liquidity preference and Fisher effect. Behind this hypothesis, the main ideas include money demand, money supply, interest rates, inflation and the role that Bank of Albania plays in the interaction of these components. The data was taken from the Bank of Albania and World Bank during time interval of years 1993-2012. This master thesis analyzed empirically the co-integrating relationship between nominal interest rate and inflation in the Albanian economy. Since the variables in this article are non-stationary and present a unit root, Johansen’s co-integration technique has been applied. This methodology has allowed for obtaining a co-integrating relationship among these variables. The co-integration results provide evidence of a unique co-integrating vector. To put in precise words, a long-run stable relationship exists between nominal interest rate and inflation. This proves that nominal interest rate and inflation move together in the long run in Albania.