Do inflation targeting central banks behave asymmetrically? Evidence from Australia and New Zealand
AbstractThis paper tests the standard quadratic approximation to central bank preferences on data from Australia and New Zealand, two of the earliest explicit inflation targeting countries. The standard linear-quadratic monetary policy model assumes central bank preferences over key macroeconomic variables, such as inflation and output, can be usefully approximated by a quadratic function. This approximation implies that a deviation from a target is considered to be equally costly irrespective of whether the deviation is positive or negative. Combined with a linear model of the economy, quadratic preferences are useful because they yield a first order condition that implies a linear interest rate reaction function. This paper relaxes the assumption of quadratic preferences by allowing central banks to regard the costs associated with positive and negative output gaps differently. Our models also test for the possibility that positive and negative deviations of inflation from target to be treated differently. During the inflation targeting period in both countries, evidence suggests that we cannot reject quadratic preferences over inflation deviations (from target). We cannot reject that New Zealand's preferences regarding deviations of output from trend are quadratic, but Australia's behaviour does not appear to be consistent with quadratic preferences. Instead, the preferences of the Reserve Bank of Australia appear to be more accurately modelled with an asymmetric loss such that the Reserve Bank of Australia views negative output gaps as more costly than positive output gaps.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP 2004/02.
Date of creation: Apr 2004
Date of revision:
Find related papers by JEL classification:
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Cukierman, Alex & Gerlach, Stefan, 2003.
"The Inflation Bias Revisited: Theory and Some International Evidence,"
CEPR Discussion Papers
3761, C.E.P.R. Discussion Papers.
- Alex Cukierman & Stefan Gerlach, 2003. "The inflation bias revisited: theory and some international evidence," Manchester School, University of Manchester, vol. 71(5), pages 541-565, 09.
- Stock, James H & Wright, Jonathan H & Yogo, Motohiro, 2002. "A Survey of Weak Instruments and Weak Identification in Generalized Method of Moments," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(4), pages 518-29, October.
- Richard Clarida & Jordi Galí & Mark Gertler, 1997.
"The science of monetary policy: A new Keynesian perspective,"
Economics Working Papers
356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
- Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
- Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
- Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
- Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
- Hansen, Lars Peter & Heaton, John & Yaron, Amir, 1996. "Finite-Sample Properties of Some Alternative GMM Estimators," Journal of Business & Economic Statistics, American Statistical Association, vol. 14(3), pages 262-80, July.
- David Card & Dean Hyslop, 1995.
"Does Inflation 'Grease the Wheels of the Labor Market'?,"
735, Princeton University, Department of Economics, Industrial Relations Section..
- David Card & Dean Hyslop, 1997. "Does Inflation “Grease the Wheels of the Labor Market”?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 71-122 National Bureau of Economic Research, Inc.
- David Card & Dean Hyslop, 1996. "Does Inflation "Grease the Wheels of the Labor Market"?," NBER Working Papers 5538, National Bureau of Economic Research, Inc.
- Alex Cukierman & Anton Muscatelli, 2001. "Do Central Banks have Precautionary Demands for Expansions and for Price Stability?," Working Papers 2002_4, Business School - Economics, University of Glasgow, revised Mar 2002.
- repec:cup:etheor:v:9:y:1993:i:2:p:222-40 is not listed on IDEAS
- Schellekens, P. & Chadha, J.S., 1999.
"Monetary Policy Loss Functions: Two Cheers for the Quadratic,"
Cambridge Working Papers in Economics
9920, Faculty of Economics, University of Cambridge.
- Chadha J. & Schellekens Ph., 1999. "Monetary policy loss functions: two cheers for the quadratic," Working Papers 1999002, University of Antwerp, Faculty of Applied Economics.
- Jagjit Chadha & Philip Schellekens, 1999. "Monetary policy loss functions: two cheers for the quadratic," Bank of England working papers 101, Bank of England.
- RUGE-MURCIA, Francisco .J., 2001.
"Inflation Targeting Under Asymmetric Preferences,"
Cahiers de recherche
2001-04, Universite de Montreal, Departement de sciences economiques.
- Ruge-Murcia, F.J., 2001. "Inflation Targeting Under Asymmetric Preferences," Cahiers de recherche 2001-04, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
- Francisco J. Ruge-Murcia, 2001. "Inflation Targeting Under Asymmetric Preferences," Banco de Espaï¿½a Working Papers 0106, Banco de Espa�a.
- Francisco Javier Ruge-Murcia, 2001. "Inflation Targeting Under Asymmetric Preferences," IMF Working Papers 01/161, International Monetary Fund.
- Douglas Staiger & James H. Stock, 1997.
"Instrumental Variables Regression with Weak Instruments,"
Econometric Society, vol. 65(3), pages 557-586, May.
- Douglas Staiger & James H. Stock, 1994. "Instrumental Variables Regression with Weak Instruments," NBER Technical Working Papers 0151, National Bureau of Economic Research, Inc.
- Philip Lowe & Luci Ellis, 1997. "The Smoothing of Official Interest Rates," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
- Cragg, John G. & Donald, Stephen G., 1993. "Testing Identifiability and Specification in Instrumental Variable Models," Econometric Theory, Cambridge University Press, vol. 9(02), pages 222-240, April.
- Orphanides, Athanasios & Wieland, Volker, 1999.
"Inflation zone targeting,"
Working Paper Series
0008, European Central Bank.
- Aaron Drew & L Christopher Plantier, 2000. "Interest rate smoothing in New Zealand and other dollar bloc countries," Reserve Bank of New Zealand Discussion Paper Series DP2000/10, Reserve Bank of New Zealand.
- Seamus Hogan, 1997.
"What Does Downward Nominal-Wage Rigidity Imply for Monetary Policy?,"
97-13, Bank of Canada.
- Seamus Hogan, 1998. "What Does Downward Nominal-Wage Rigidity Imply for Monetary Policy?," Canadian Public Policy, University of Toronto Press, vol. 24(4), pages 513-525, December.
- James H. Stock & Motohiro Yogo, 2002. "Testing for Weak Instruments in Linear IV Regression," NBER Technical Working Papers 0284, National Bureau of Economic Research, Inc.
- Barro, Robert J & Gordon, David B, 1983.
"A Positive Theory of Monetary Policy in a Natural Rate Model,"
Journal of Political Economy,
University of Chicago Press, vol. 91(4), pages 589-610, August.
- Robert J. Barro & David B. Gordon, 1983. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
- George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
- Alvaro Aguiar & Manuel Martins, 2008.
"Testing for asymmetries in the preferences of the euro-area monetary policymaker,"
Taylor & Francis Journals, vol. 40(13), pages 1651-1667.
- Alvaro Aguiar & Manuel M. F. Martins, 2005. "Testing for Asymmetries in the Preferences of the Euro-Area Monetary Policymaker," FEP Working Papers 182, Universidade do Porto, Faculdade de Economia do Porto.
- Manuel M F Martins & Alvaro Aguiar, 2005. "Testing for Asymmetries in the Preferences of the Euro-Area Monetary Policymaker," Money Macro and Finance (MMF) Research Group Conference 2005 41, Money Macro and Finance Research Group.
- Matthew Doyle & Barry Falk, 2009.
"Do Asymmetric Central Bank Preferences Help Explain Observed Inflation Outcomes?,"
0902, University of Waterloo, Department of Economics, revised Feb 2009.
- Doyle, Matthew & Falk, Barry, 2010. "Do asymmetric central bank preferences help explain observed inflation outcomes?," Journal of Macroeconomics, Elsevier, vol. 32(2), pages 527-540, June.
- Doyle, Matthew & Falk, Barry L., 2006. "Do Asymmetric Central Bank Preferences Help Explain Observed Inflation Outcomes?," Staff General Research Papers 12501, Iowa State University, Department of Economics.
- Cinzia Alcidi & Alessandro Flamini & Andrea Fracasso, 2011. "Policy Regime Changes, Judgment and Taylor rules in the Greenspan Era," Economica, London School of Economics and Political Science, vol. 78(309), pages 89-107, January.
- Shawn Chen-Yu Leu & Jeffrey Sheen, 2005.
"Asymmetric Monetary Policy in Australia,"
2005.02, School of Economics, La Trobe University.
- Philip Liu, 2004. "Improving implementation of inflation targeting in New Zealand: an investigation of the Reserve Bank's inflation errors," Reserve Bank of New Zealand Discussion Paper Series DP 2004/06, Reserve Bank of New Zealand.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Reserve Bank of New Zealand Knowledge Centre).
If references are entirely missing, you can add them using this form.