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Inflation Targeting and Variability of Money Market Interest Rates Under a Zero Lower Bound

Karel Brůna () and Quang Tran

Czech Journal of Economics and Finance (Finance a uver), 2018, vol. 68, issue 6, 519-539

Abstract: The paper presents a formal framework of money market interest rates variability under a zero lower bound in a monetary policy strategy of inflation targeting. The potential factors influencing the variability of money market interest rates are con-sidered within a near zero level of main policy rate variability. At the same time, model optimal main policy rate shows significant volatility due to changes in the structural characteristics of economy facing deep economic and financial shocks, changing perception of inflation risks, central bank’s weakened credibility and uncertainty about the efficient transmission of monetary measures. The money mar-ket interest rates are modeled in the framework of VAR model with exogenous vari-ables using the example of the Czech economy for a period 2000-2016. The model is estimated by Bayesian method and its structural form is obtained through sign re-striction. The repo rate and money market interest rates are decomposed into a series of cumulative structural shocks of each endogenous component in the model. The results show that global financial crisis and the exchange rate alternative monetary policy measures are two main sources of endogenous variables’ shocks for interest rates which confirm high importance of net export, banking loans and investment for the dynamics of an open economy.

Keywords: money market interest rates; volatility; inflation targeting; zero lower bound; Bayesian VAR; His-torical decomposition (search for similar items in EconPapers)
JEL-codes: E43 E44 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:fau:fauart:v:68:y:2018:i:6:p:519-539