Interest rates are a key determinant of economic activity, particularly with regard to

consumption. Changes in interest rates can affect borrowing costs, return on savings,
and debt burden, all of which can influence levels of consumption in an economy.
The relationship between inflation rate and interest rate has been mentioned by Fisher
effect theory for a long time. The Fisher effect is a theory developed by Fisher (1930)
that expresses the real interest rate as the difference between the nominal interest rate
and the expected rate of inflation. The most common expression of this relationship is
that the expected nominal rate of return on assets is equal to the expected rate of
inflation plus the expected rate of real return. According to the Fisher effect, expected
nominal returns on assets should fully hedge against inflation. Therefore, a positive
relationship between stock returns and inflation is expected, which implies that
investors are compensated for the loss of purchasing power resulting from inflation.
Affter being published, there are a lot of questions occurred around the reliability of
the theory. Many researches have been conducted. In 1992, Frederic S. Mishkin
indicated that although the Fisher effect is generally considered to be strong, with a
substantial correlation between interest rates and inflation, this is not always the case
and may only occur during certain time periods. Recent empirical evidence does not
provide support for a short-term Fisher effect in which an alteration in projected
inflation is linked to a modification in interest rates. However, it does confirm the
existence of a long-term Fisher effect in which inflation and interest rates share a
common stochastic trend, particularly when they display trends. Similarly, a study by
Yasser A.F Fahmy , Magda Kandil (2003) has shown the similar result.
In general, whaterver the reliability, in real life, the relationship between inflation and
interest rate are undeniable. It seems that, interest rate rise in the inflation and fall in
the recession.
Impact of interest rate on consumption through debt burden:
According to the study of John A. Weinberg (2006), the burden of servicing debts
tends to rise during economic expansions and decrease during recessions. This pattern
is influenced by two primary factors. Firstly, interest rates tend to increase during
periods of economic expansion and decrease during recessions. Secondly, the rate of
growth of consumer credit is also procyclical, with credit typically expanding at a
faster rate during periods of economic expansion, on average. Remember that, when
debt burden increases, the consumers’ disposable income will decrease. This means
that consumers may have less money available to spend on consumption. Therefore,
we propose an assumption:
H : In the period of high inflation, the interest rate tends to increase that leads to
heavier debt burden which in turn lower the consumption in Vietnam.