Interest Rate Determination in Small Developing Countries

This paper investigates the validity of Fisher’s hypothesis in determining nominal interest rates for five small developing countries—The Bahamas, Barbados, Guyana, Jamaica, and Trinidad and Tobago. We augment the traditional Fisher test equation by introducing the US nominal interest rate. Results indicate that there is a long run relationship for The Bahamas and Trinidad and Tobago; and for Jamaica during the period when the country is under a floating exchange regime. The nominal interest rate in each of the latter countries is positively related to the US nominal rate. Specifically, in The Bahamas the relationship is one-for-one, and for the others it is greater than one-for-one. Expected inflation only has an effect in Jamaica and Trinidad and Tobago, although the relationship is negative in the case of the latter. Fisher’s hypothesis, even in its augmented form, does not appear to be a suitable framework for determination of nominal interest rates for Barbados and Guyana