How Does Monetary Policy Change? Evidence on Inflation Targeting Countries

Jaromir Baxa, Roman Horvath and Bořek Vašíček ()

No 2010/26, Working Papers IES from Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies

Abstract: 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 a moment-based estimator in a 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 a time-varying estimation framework. Second, the interest rate smoothing parameter is much lower than typically reported by previous time-invariant estimates of policy rules. External factors matter for all countries, although the importance of the exchange rate diminishes after the adoption of inflation targeting. Third, the response of interest rates to inflation is particularly strong during periods when central bankers want to break a record of high inflation, such as in the UK or Australia at the beginning of the 1980s. Contrary to common wisdom, the response becomes less aggressive after the adoption of inflation targeting, suggesting a positive anchoring effect of this regime on inflation expectations. This result is supported by our finding that inflation persistence as well as the policy neutral rate typically decreased after the adoption of inflation targeting.

Keywords: Taylor rule; inflation targeting; monetary policy; time-varying parameter model; endogenous regressors (search for similar items in EconPapers)
JEL-codes: E43 E52 E58 (search for similar items in EconPapers)
Pages: 49pages
Date: 2010-10, Revised 2010-10
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Related works:
Journal Article: HOW DOES MONETARY POLICY CHANGE? EVIDENCE ON INFLATION-TARGETING COUNTRIES (2014)
Working Paper: How Does Monetary Policy Change? Evidence on Inflation Targeting Countries (2010)
Working Paper: How Does Monetary Policy Change? Evidence on Inflation Targeting Countries (2010)
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