Publication detail

How Does Monetary Policy Change? Evidence on Inflation Targeting Countries

Author(s): PhDr. Jaromír Baxa Ph.D., Vašíček, Bořek
prof. Roman Horváth Ph.D., Vašíček, Bořek
Type: Others
Year: 2009
Number: 255
Published in: UTIA AV CR, Research report
Publishing place: Praha
Keywords: Taylor rule, inflation targeting, monetary policy, time-varying parameter model, endogenous regressors.
JEL codes: D70, K42, O12, Z13
Suggested Citation: Baxa, J., Horvath, R., Vasicek, B.: How Does Monetary Policy Change? Evidence on Inflation Targeting Countries.Institute of Information Theory and Automation, Academy of Sciences of the Czech Republic, Research Report No. 2255.
Grants: 402/09/H045 - Nelineární dynamika v peněžní ekonomii a financích. Teorie a empirické modely
Abstract: In this paper, we examine the evolution of monetary policy rules in a group of inflation targeting
countries (Australia, Canada, New Zealand, Sweden and the United Kingdom) applying moment
estimator at time-varying parameter model with endogenous regressors. This methodology has
several important advantages for estimation of policy rules. In particular, unlike the Markovswitching
methods, it models the policy as gradually evolving rather than imposing its sudden
switches from (one regime to another). It also deals with the issue of endogeneity in policy rules
and delivers superior statistical properties in small samples than the traditional Kalman filtering.
Our main findings are threefold. First, monetary policy changes gradually pointing to the
importance of applying time-varying estimation framework. Second, the interest rate smoothing
parameter is much lower that what previous time-invariant estimates of policy rules typically
report. External factors matter for all countries, albeit the importance of exchange rate
diminishes after the adoption of inflation targeting. Third, the short-term response of interest
rates on inflation is particularly high during the periods, when central bankers want to break the
record of high inflation such as in the U.K. or in Australia at the beginning of 1980s. Contrary to
common wisdom, the response becomes less aggressive after the adoption of inflation targeting
suggesting the positive effect of this regime on anchoring inflation expectations. This hypothesis
is supported by our finding that inflation persistence as well as policy neutral rate typically
decreased after the adoption of inflation targeting.


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