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 |
| ISSN / ISBN: | |
| 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. |
