How the central bank’s reaction function in small open economies evolved during the crisis

The experience of the global financial crisis caused central banks to change the way the monetary policy is conducted, in particular it changed their reaction function. This study investigates how four selected European central banks in small open economies have changed their reaction function in response to the GFC. To address this problem a logit model is used to see, firstly, how the relative importance of GDP growth forecasts in the process of setting interest rates evolved over time, secondly, how the CPI forecast horizon which central banks take into consideration has changed and, finally, how the monetary policy stance has changed. The outcomes indicate that all banks in the course of the crisis have become more flexible in the way they conduct monetary policy – Polish and Hungarian central banks increased the relative importance of GDP growth as compared to inflation development, Czech and Swedish central banks increased the forecast horizon for inflation and all but the Swedish central bank started to conduct a more accommodative monetary policy.