A NOTE ON TIME VARIATION IN A FORWARD-LOOKING MONETARY POLICY RULE: EVIDENCE FROM EUROPEAN COUNTRIES

N Kishor

Macroeconomic Dynamics, 2012, vol. 16, issue S3, 422-437

Abstract: This paper estimates time-varying forward-looking monetary policy reaction functions for the central banks of France, Germany, Italy, and the United Kingdom. We utilize the framework developed by Kim [Economics Letters 91 (2006) 21–26] and Kim and Nelson [Journal of Monetary Economics (2006) 1949–1966] to deal with the issue of endogeneity in a time varying–parameter model. Our results find substantial time variation in the conduct of monetary policy in these four countries, which cannot be adequately captured by the conventional fixed-coefficient approach. Our findings suggest that there was a significant decline in the Bank of France's and the Bank of Italy's response to the German interest rate in 1992, and it coincided with the breakdown of the exchange rate management system in Europe. Our results suggest that the Bank of England was slower than the Bundesbank to increase its response to expected inflation, as its response to inflation became more than one-for-one only in the early 1980s.

Date: 2012
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