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How Does Monetary Policy Change? Evidence on Inflation Targeting Countries

  • Jaromír Baxa

    ()

    (Institute of Economic Studies, Charles University, Prague and Institute of Information Theory and Automation, Academy of Sciences of the Czech Republic, Prague)

  • Roman Horváth

    ()

    (Czech National Bank and Institute of Economic Studies, Charles University, Prague)

  • Borek Vasícek

    ()

    (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona)

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- based estimator at time-varying parameter model with endogenous regressors. Using this novel flexible framework, our main findings are threefold. First, monetary policy rules change 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 response of interest rates on inflation is particularly strong 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 result is supported by our finding that inflation persistence as well as policy neutral rate typically decreased after the adoption of inflation targeting.

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File URL: http://www.ecap.uab.es/RePEc/doc/wpdea1007.pdf
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Paper provided by Department of Applied Economics at Universitat Autonoma of Barcelona in its series Working Papers with number wpdea1007.

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Length: 53 pages
Date of creation: Sep 2010
Date of revision:
Handle: RePEc:uab:wprdea:wpdea1007
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