Sensitivity of Interest Rates to Inflation and Exchange Rate in Poland: Implications for Direct Inflation Targeting

Lucjan Orlowski

Comparative Economic Studies, 2017, vol. 59, issue 4, No 6, 545-560

Abstract: Abstract This study examines sensitivity of short-term interest rates to inflation and exchange rate in Poland over the past two decades. It aims to ascertain a relative role of inflation and exchange rate stability objectives for monetary policy. A model of short-term interbank interest rates as a function of CPI inflation and the nominal effective exchange rate is proposed and tested for stability, structural breaks and regime shifts. The Bai–Perron multiple breakpoint and two-state Markov regime switching tests are employed on monthly data for January 1994–December 2016 period. The tests point to a major structural break and to a regime change in the beginning of 2002. Its timing reflects the de facto inflation targeting becoming an effective and credible policy. The findings further suggest that the inflation targeting helped mitigate potential contagion effects of the 2008–2010 financial crisis.

Keywords: direct inflation targeting; de facto inflation targeting; nominal effective exchange rate; convergence to the euro; Bai–Perron multiple breakpoint; Markov regime switching; E42; E43; P24 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1057/s41294-017-0035-3

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