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Optimal monetary policy reaction function in a model with target zones and asymmetric preferences for South Africa

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Author Info

  • Ruthira Naraidoo

    ()
    (Department of Economics, University of Pretoria)

  • Leroi Raputsoane

    (Department of Economics, University of Pretoria)

Abstract

This paper estimates the optimal monetary authorities’ response to deviations of inflation and output from their target values for South Africa over the inflation targeting era. This is achieved using an empirical framework that allows the central bank’s policy preferences to be zone-like as well as asymmetric. The main findings are that the monetary authorities react in a passive manner when inflation is within the target band and become increasingly aggressive when it deviates from the target band and that they react with the same level of aggressiveness regardless whether inflation overshoots or undershoots the inflation target band, that is, the monetary authorities’ response towards inflation is zone symmetric. The second major finding shows that the monetary authorities’ response to output fluctuations is asymmetric such that they react more aggressively to negative deviations of output from the potential, therefore weighing more business cycle recessions versus expansions.

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Bibliographic Info

Paper provided by University of Pretoria, Department of Economics in its series Working Papers with number 201004.

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Length: 20 pages
Date of creation: Mar 2010
Date of revision:
Handle: RePEc:pre:wpaper:201004

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Keywords: monetary policy preferences; target zones; asymmetries;

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References

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  1. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
  2. Orphanides, Athanasios & Wieland, Volker, 1999. "Inflation zone targeting," Working Paper Series 0008, European Central Bank.
  3. RUGE-MURCIA, Francisco .J., 2001. "Inflation Targeting Under Asymmetric Preferences," Cahiers de recherche 2001-04, Universite de Montreal, Departement de sciences economiques.
  4. Dolado, Juan J. & Maria-Dolores, Ramon & Naveira, Manuel, 2005. "Are monetary-policy reaction functions asymmetric?: The role of nonlinearity in the Phillips curve," European Economic Review, Elsevier, vol. 49(2), pages 485-503, February.
  5. Athanasios Orphanides & David W. Wilcox, 1996. "The opportunistic approach to disinflation," Finance and Economics Discussion Series 96-24, Board of Governors of the Federal Reserve System (U.S.).
  6. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
  7. DOLADO, J.J. & MARIA-DOLORES, R. & RUGE-MURCIA, Francisco J., 2003. "Nonlinear Monetary Policy Rules: Some New Evidence for the U.S," Cahiers de recherche 2003-24, Universite de Montreal, Departement de sciences economiques.
  8. Ruthira Naraidoo & Rangan Gupta, 2009. "Modelling monetary policy in South Africa: Focus on inflation targeting era using a simple learning rule," Working Papers 200904, University of Pretoria, Department of Economics.
  9. Surico, Paolo, 2007. "The Fed's monetary policy rule and U.S. inflation: The case of asymmetric preferences," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 305-324, January.
  10. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  11. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  12. Paolo Surico, 2007. "The Monetary Policy of the European Central Bank," Scandinavian Journal of Economics, Wiley Blackwell, vol. 109(1), pages 115-135, 03.
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