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The asymmetric reaction of monetary policy to inflation and the output gap: Evidence from Canada

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  • Komlan, Fiodendji

Abstract

This paper empirically analyzes the interest rate behavior of the Canadian monetary authorities by taking into account possible asymmetries in the loss function. We employ a switching regime framework using two estimation strategies: First, we follow Caner and Hansen's (2004) threshold approach. Under this procedure we estimate, using the Taylor empirical rules, the threshold values. Second, to infer the monetary policy preferences and have the best interpretation of the parameters, we use these threshold values to estimate the specification of asymmetric policy reaction function following Favero and Rovelli's (2003) approach. The results reveal that the Canadian monetary authorities showed asymmetric preferences; hence its reaction function can be better modeled as a nonlinear model. The results also imply that the monetary authorities' preferences have changed between different subperiods and different regimes. In particular, the parameter associated with the implicit target of inflation has been reduced significantly. We find strong statistical support for this decline, a result that is consistent with previous findings by Favero and Rovelli (2003) for the case of US and Rodríguez (2008) for Canada. The main contribution of this paper is to make out the presence of nonlinearities and asymmetries in the Canadian reaction function and to be able to interpret the parameters associated with the preferences of the central bank. This provides empirically interesting extension to Rodriguez (2008).

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  • Komlan, Fiodendji, 2013. "The asymmetric reaction of monetary policy to inflation and the output gap: Evidence from Canada," Economic Modelling, Elsevier, vol. 30(C), pages 911-923.
  • Handle: RePEc:eee:ecmode:v:30:y:2013:i:c:p:911-923
    DOI: 10.1016/j.econmod.2012.09.046
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    3. Tiwari, Aviral Kumar & Oros, Cornel & Albulescu, Claudiu Tiberiu, 2014. "Revisiting the inflation–output gap relationship for France using a wavelet transform approach," Economic Modelling, Elsevier, vol. 37(C), pages 464-475.
    4. Sznajderska, Anna, 2014. "Asymmetric effects in the Polish monetary policy rule," Economic Modelling, Elsevier, vol. 36(C), pages 547-556.
    5. de Sá, Rodrigo & Savino Portugal, Marcelo, 2015. "Central bank and asymmetric preferences: An application of sieve estimators to the U.S. and Brazil," MPRA Paper 72746, University Library of Munich, Germany.
    6. Ahmad, Saad, 2016. "A multiple threshold analysis of the Fed's balancing act during the Great Moderation," Economic Modelling, Elsevier, vol. 55(C), pages 343-358.
    7. Fiodendji, Komlan, 2015. "Que Nous Révèlent les Fonctions de Réaction à Propos des Préférences des Banques Centrales?
      [What Do Reaction Functions Tell Us About Central Bank’s Preferences?]
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    8. de Sá, Rodrigo & Portugal, Marcelo S., 2015. "Central bank and asymmetric preferences: An application of sieve estimators to the U.S. and Brazil," Economic Modelling, Elsevier, vol. 51(C), pages 72-83.
    9. Mustafa Caglayan & Zainab Jehan & Kostas Mouratidis, 2016. "Asymmetric Monetary Policy Rules for an Open Economy: Evidence from Canada and the Uk," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 21(3), pages 279-293, July.

    More about this item

    Keywords

    Asymmetric or nonlinear preferences; Interest rate rule; Inflation targeting; Output gap; Generalized method of moments; Threshold effects;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models

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