Taylor Rules

CEU eTD Collection In partial fulfillment of the requirements for the degree of Master of Arts E Supervisors: Professor Max Gillman and Professor Katrin Rabitsch STIMATING AND T Central European University European Central AYLOR Department of Economics Giorgi Tarkhan-Mouravi E Budapest, Hungary ASTERN Submitted to Submitted -T 2009 By YPE E R UROPE ULES IN C ENTRAL CEU eTD Collection study at CEUand my friends,CEU made who the studyingfun. period making process the of writing thesis the enjoyable. in contributed who department, CEU economics staff at administrative the andpaper to of language the and style the regarding comments useful his for Rooney Thomas thank to want I subject. the chose me to motivated Economics” “Monetary course whose excellent forGillman, Max directing processof Especially meduringthesis Gillman, the writing. paper gained alot from her valuable suggestions. sideof stylistic The support andencouragement. the hergreat accomplished without I want to thank my girlfriend Ilona Ferenczi, the thesis could not have been have not could thesis the Ferenczi, Ilona girlfriend my thank to want I Finally, I want to thank my family for their great support during all the time of my during my family to thanksupport all Finally, timeforthe of I want great their Max andProfessor Rabitsch Katrin Professor my supervisors, thank to want I Acknowledgments i CEU eTD Collection PEDX...... 35 APPENDIX...... 30 V. CONCLUSION...... IV. THE 14 ESTIMATION RESULTS...... III. DATA DESCRIPTION 10 AND METHODOLOGY...... II. COUNTRY DESCRIPTION...... 8 II. THE TAYLOR RULE ...... 3 LITERATURE REVIEW I. INTRODUCTION...... 1 ABSTRACT...... III OFCONTENTS TABLE .SmigU ...... 25 E. Summing Up ...... 23 D. Romania C. Poland...... 21 B. Hungary...... 19 A. The Czech Republic...... 15 ii CEU eTD Collection short-term interest rates remarkably rates interestwell. short-term forms of the Taylor rules illustrates in policy the Romania.shiftof Finally,thepaperprovides thespecificfunctional the analyzed countrieswith theory the offered by Obsfeld andRogoff (1995) aswell as Taylorthat and (2001), track the historicline in by CzechRepublic, function Hungary and the inthepolicy reaction consideration record of the explicit rate exchange of evidence some Additionallybank. paperprovides the one gets the opposite results, based on the assumption of the target horizon of the central in thecaseof Hungary yet robust, surprisingly are specifications from different estimates the CzechRepublic the caseof In the interestingnumberresults. horizons of a Isuggest forecast andmethods specifications, Using different the targets. inflation with economies This paper setout estimateto Taylor-type for rules four emerging European Abstract iii CEU eTD Collection that would limit inflationadopted bound andarenottargeting to anyformal mechanismexchange rate their Republic,monetary Hungary, policy.Polandthe and centralRomania, The i.e. commonly the emergingbanks EU countries,usedisif all. cat knowing the at there of check thewho already fourofConfucius’ classic saying: searching ina black cat a darkroom and with not even robustness Central to activity compared this ironically (2005)) Tchaidze and (Carare Some authors in andsamples. and data methods, estimation on sensitive out turned rules The Eastern sample. same European andreport of problems estimation, to conflicting causingmanyauthors results onthe theCountries: simple rules turned out in monetary Yet, findingpolicy new for component asystematic opened. line of research not to be thatthe simple the well, remarkably Federal Reserve to of the Czechbehavior rate-setting interest the summarizes identify, with variousa simplerule discovered that (1993) surprisingly,Taylor not when Hence, instability. shortcomings problem of commit inconsistency bybeingtime to able the and eliminate potential the avoid rules the discretion, Unlike and check. communicate easy to transparent, and simple are they criteria: main the meet They instruments. policy becoming for attractive candidates most rules becamethe Taylor-type the demand.sense this In monetary rulestargeting largeby the growth of money are plagued scaledisturbances the and be unattainable to proved cases in many rates exchange fixed The payoff. best the gives policy monetary credible and consistent the alternatives other all from be that If we were to name something thatmacroeconomists agree on nowadays, it would This paper is my attempt to identify such systematic patterns in the behavior of I. Introduction 1 CEU eTD Collection the fifth section concludes. fifth section the and findings and estimates the report I section fourth in the methodology; and data my in I present third section the countries; of analyzed the policies themonetary summarized section second the Taylor rule; the on literature existing previously of overview ones. estimated of set the from model best the choosing of possibility the gives it lastly, and applied; methods estimation the on sensitivity the illustrates methods; single certain of bias the from hedging of possibility gives it advantages: many has believe, I estimation, in exercise check Iapply all mentionedthe specifications on quarterlythe monthlyand This data. and For forward-looking robustness open-economy the rule Taylor andits counterpart. counterpart smoothing interestandits open-economy with Taylor rule contemporaneous counterpart, its open-economy and Taylor rule simple Iconsider: Namely, data. same tothe of methods estimation apply to different approach, adifferent choose estimation of Taylor-type rules is employing the different type of data; However, I The structure of the paper is as follows: the first section is acomprehensive section follows: the first is as of paper the The structure 2 CEU eTD Collection price level and real output. focus not directlythey that performance aspolicies todeliver appeared the on good such since them rejected he however, supply; money the on and rate exchange on additionally GDP. He also considered other representations of policy rules, namely those that focus Where bank convincing gives signal market the isto that to fight willing inflation. increase hencecentral in canmirror innominal real rate, increase the rate implies that rule Taylor original the In trend real GDP), (defined as a deviation of real GDP from its target: relation: thefollowing Namelyheadvocated one. from itsfrom level of desiredactual inflation actual output and deviation potential the simple rule: the 1987-1993waswell-described bya monetary the period the policy USduringthe of short-term that argued banks. (1993) Taylor central function nominalof summarize thereaction to method interest rates react positively on the deviation of Equation (1) can be rewritten as canbe(1) rewritten Equation i During decades,Taylor the lasttwo typebecome havemost rules popular the Taylor set both is the nominal federal funds is federal rate, nominal the iry tt t t iry II. The Taylor Rule Literature Review ttttt  r   * is equilibrium federal funds rate fundsrate and federal is equilibrium ** ** SDSE DS r DSE SDSS * and D (1) and () ) ( S t * equal to 2, and 2, to equal E are both given weights 0.5. Stability condition Stability 0.5. weights given both are 3 (2) S is the inflation rate, Y * as a 2.2 percent linear trend of of linearReal trend asa2.2percent YYY y S  t * 0()/ ) 100( is equilibrium inflation rate. inflation isequilibrium ** y is the output gap (1) , where Y D * >0 is CEU eTD Collection coefficient show that the and sign of responsewhere of the real rate target gap: and output depends oninto incorporatesmoothing. Taylor They inflation specification valuesfuture expected of weather inflationintroducinglooking aforward in element Taylorthe rule and considering interest rate. interest future toexploit dependency the of on expected large demand policy andreversals wants and sudden by credibility lose and markets capital and money distort to fears bank central a is that smoothing behind rational A common reversals. very rare with direction, one in and slowly rates interest change they when banks, central many by exhibited behavior smoothing,such consider Further, originalnotchanges. the interest rate does rule to unresponsive relatively be will they that sense in output, and inflation to movements toreacton contemporaneous banks allow central to less makeit justifiable andhence inflation ason aswell quarters several after output the on real effect significant have a hikes thatinterest rate Empirics show introduction. havecome upsince its various issues Fed, the policy of monetary well the really approximate to therule seems Although : t i Many researchers followed Taylor in estimating central in followedbank function. Many estimatingcentral Taylor response researchers Popular approach was suggested by Clarida, Gali and Gertler (1997 and 2000) by by and Gali suggested 2000) (1997and Gertler PopularClarida, approach was is the information set, available at the time t when interest rate is set. Itis is rate set. easy to interest time twhen atthe available set, information is the t * is the nominal interest rate, interest nominal isthe M is smallergap coefficient greateror and the output than 1 Ey E i i ktt t tm t tk t *** :º ª   :  SSE MS () ^  ` i * is the desired (equilibrium) nominal interest rate interest nominal (equilibrium) desired the is 4 ¬¼ (3) E is greater or CEU eTD Collection bank: implied byequation (5) and utilizingfrom instruments setof the information central of Method of Moments (Hansen byimposing 1982) orthogonality momentconditions interpret rate moves upwards only if 1 data. time real versus use current to is whether concerns themain of rules. One set information the where rate. target where process: Gertler allow the interestdepend rate itsto on laggedvalues through partial adjustment Principle. Taylor called so is the This 0. than smaller term Ey E r r ri U Real ex ante interest rate can be written as ktt t tm t tk t *** *** near unity indicates that central bank adjusts interest rates very slowly towards their towards slowly very rates interest adjusts bank central that indicates unity near  :º ª   :   H : HUMSSE UUUU t Many raised authors methodological concernsand practical over Taylor-type By combining (3)and(4) we get: kt kt t tk tk t tk tk t hence is a linear combination of forecast errors and orthogonal to the variables in variables the to orthogonal and errors forecast of combination linear is a hence t ... ) ( S . { :: LL L U (1)() SE S M . By thesesubstituting conditions into equation(3) we get   (1)()()  > Li y i i iLii 12 0,1 kt t t tk tk t ttt          @ ^ (1) (1) () (1) (1) UU : as an indicator of the degree of interest rate smoothing. The value of value smoothing. The rate interest of of degree asanindicator the ^ () (1) t . Clarida, Gali and Gertler estimate the equation using Generalized using equation the estimate Gertler and Gali . Clarida, UMSUMSUEUH M  ,, ,  >1 and/or >1 ^ 1 ** Ey y E ` ^ n n  1 E , * >0 and downwards otherwise. (4) ` UU ` riE tkt t t { ** : ¬¼ (1) 5 and ^ S ^ ,1 , i  t , from where it is straightforward that real that straightforward is it where from , is 1 Moreover, Clarida, Gali and ` actual ` and real equilibrium interest rate as ` t . The composite error funds rate. The authors The funds rate.  (5) CEU eTD Collection type rule can be derived where coefficient of inflation of coefficient where bederived can type rule Taylor- the conditions first-order from that demonstrate they problems, supply money producer,By analyzing the consumer, the goods the bankingfirm government and the equilibrium model, with endogenous foundedgrowth economy and micro banking sector. be(2008) showthatneed this thecasebyderiving not the Taylor rule general using generally are assumed as additional equilibrium condition of economy. Gillman et al. equation. Taylor inthe term correction error an integrating by solution the They offer rate. interest and in inflation ignoreroot unit to used simply Researchers developed economies: on the economies with developed asset markets and with ahigh markets and with asset developed with ontheeconomies developedeconomies: function. utility isoelastic in aversion risk relative constant to gap corresponds output on and coefficient “Taylor principle”) case of most arebased of existingon and the estimates that conclude is Siklosliterature, thepossibility aunitandWoharroot. of the problem (2004)address yields differentresults (Siklos andWohar (2004)). sample periods for different estimation the and gap areregime sensitive, and output (Kozicki (1999)). Moreover,estimation significantly inflation fordiffers depending onwhichis proxy output used or it is argued that the proxy variables by how to estimates inTaylor asdemonstrated the rule, since, some authors, is question on important coefficientsAnother estimates. the changes significantly one (ex-post) current of inflation of instead data time real useof the that onUSdata demonstrates Orphanides (2001) Taylor rules are assumed relations in sense that they rose in empirical studies and studies in empirical rose they that sense in relations assumed are rules Taylor The majority of researches into Taylor-type rules were conducted on the One aspect important of Taylor-type of widelyrules, missed in previousthe 6 M corresponds to 1 (the marginal unbalanced regression . CEU eTD Collection Some authors report other important variables in deciding stance of monetary importantmonetary report variablesstanceSome indeciding for of policy other authors targeting. exhibitexchangeCentral still countries, although European some rate countries of exchange Schobert(2006) show thatrate after introduction floatingof exchange regime theimportance in setting and Frommel targeting. rate exchange as can be classified even extentthat the cases to monetaryfindandmany Klau(2004) that banks tointerest central ratechangesreact and insome policy declinedand gap.From output their sampleof 13 relatively Mohanty advancedmarkets emerging inflation for just than variables other consider should one theeconomies, market in emerging sample of Eastern and aspolicy instrument. rate rather thaninterest rate) exchange andrate interest combination of (the Index use Monetary Condition to and proposes economies small, the for emerging open, mightbe dangerous consideration exchange rate economyinthe Ball argues inflation markets. (2002) that open without targeting influence to way fastest is the pass-through rate exchange that account into taking rule, in for (3)there effect; shouldthe the rate besome exchange onexpectation room count since highly they liquidlongeconomic term without markets events, securities cannot shouldmarkets (2)emergingeconomies; more respond by quickly and largerto amounts inthose rate interest real equilibrium measuring of difficulties the to due markets, as a policy emergingrate for ofinterestcanbeinstead instrument more appropriate highlights possiblethe differences in monetary usepolicy: (1)the monetary of aggregates he Nevertheless, economies. as indeveloped advantages same the practiced, with inflation is be markettargeting especially emerging where economies, applied the to mobility.degree ofcapital Taylor (2000)arguesthat Taylor-type However, rules canalso However, itis clear that when trying estimateto reaction function of central banks 7 CEU eTD Collection Euro zone. Euro entering for a condition Mechanism), Rate Exchange (European II ERM to bound yet not they are Union, but members of are European they all arethat economies these between similarities and Romania. The Poland Hungary, Republic, the Czech economies: market is unable to pursue independent monetary policy. 2 of large shockchanges in which factors, exogenous in control are not monetary of policy. occurrence inthe caseof from inflation targeting bank clause The central has rate. escape weeks repo importantly most key two are rates, achieveinterest to target the instruments of inflation main CNBhas 2005the objective.1-3%; the Since target pursuedan Bank (CNB) tomaintain but stability only price in change the way the of this achieving 1998; howeverinclude thisdidnot change the inthe objective of CzechNational the regimes. rate exchange as their well as the analyzed countries of monetary policy of basic characteristics review havecountries directinflation movedalready to targeting. In this section I will briefly their own and not to limit it by adjusting it to the policy of ECB. Moreover, all these for Chile (Corbo(2002)). toGDPmatters account of for deficitcurrent example America, inLatin countries some I do not analyze Bulgaria another EU country who is not yet in ERM II, since because of currency board I estimate Taylor-type rules for four Central and Eastern European emerging European Eastern and four Central for rules Taylor-type I estimate The Czech Republic was first to adopt inflation adopt firstbeginninginThe Czech Republic targeting the wasof to 2 Hence these countries have relative freedom to run a monetary policy of II. Country description 8 CEU eTD Collection analyzed period, as now it followed managed float. The Romanian National followed TheRomanian asnowanalyzed period, it National Bank (RNB) managed float. fixed the analyzed regime, wasnever during other countries, the exchange rate unlike level inflation hasbeenof 2.5% with percentagea +/-1 point band.The deviation withband percentage pointEuro, free float of a against startingForint afterwards. 2001 until February 2008 Hungarian Forinthad awide crawlingpeg with +/- 15 pointFrom permissible +/-1percentage continuous deviation. inflation of 3% with target ismarketrate achieve twoweeksMNB-bill) to stability. price MNB pursues the money month three influence to instrument important most (the rate market money term short adjusts (MNB) Bank Nemzeti Magyar The targeting. rate exchange of policy website of NBC states (The National Bank of Poland). as official the target” inflation toachieve in order necessary this deems “if it intervene bankto currencies.has theright However,central other against pursued officially floatunrestricted inApril is band 2000 andnopredetermined of Zloty rate exchange peg against basket the of currencies was and startedabandoned an Zloty rate exchange The crawling ofpoint. band+/-with target 1percentage fluctuation of continuous 2.5 % has pursued NBP the2004 the Since beginning of operations. reserves andcredit-deposit market with open operations, required followinginstruments: use rate, the interest of order to the achieve target the National float. started managed that after Bank of Poland The (NBP)Czech Coruna maintained fixed regime exchange rate from May 1994 to of 1997 and adjusts the NBP basic Romania adopted directinflationRomaniain adopted summer2005.Since targeting target2008 the inflationHungary started thus insummerchanging the targeting 2001, previous Poland,adopt seconddirect the inflation to itintroduced intargeting, 1999. In 9 CEU eTD Collection suggested by authors the (Hodrick, Prescott(1997)). 3 real GDP or using band-pass filter. are common methods of fitting quadratic potential linearderiving output time trends to or Other impact. exaggerated have points last the series the of end the at when problem, endpoint a well-known from suffers it series time of components cyclical and structural long in tradition TaylorAlthough rule literature. thefilteris a useful tool to separate monthly frequency. value for quarterly filtered (H-P) itswith Hodrick-Prescott log of GDP between gap as a difference output frequency quarterly frequency and Industrial for monthly(IP) Production frequency. Iestimate andmultiplied bydefining100. For gapI use Gross output domestic (GDP)for Product between log of IP withCensus XII. its H-P filtered using seasonally Iadjust andothers source the at adjusted seasonally already were series valueIMF website spanning period the January 1996 toJanuary most2009. In cases the time for inflation hiteven a 3digitnumber (160%). Moreover, Romania is the country with the average highestinflation rates and in 1997 the targeting. inflation explicit started it before policy monetary official announced never For monthly frequency I use the value of multiplier I estimate inflation by rate annual inlogchange of Consumer Index Price (CPI) myFor analysis Iuse monthlythe and quarterly frequency obtained data from the III. Data Description and Methodology 3 To proxy by hasfilter To applying H-P potential on real a output 10 O =14,400 and for quarterly frequency – frequency quarterly for and =14,400 O =1,600 as CEU eTD Collection However, since the target of one-quarter-ahead inflation seems plausible as well (and aswell plausible seems inflation of one-quarter-ahead target the since However, month month mediumto in but changes care about prices,long and term targets. m= and inflation. 4 monthly frequency oneyear(for forinflation forecast horizon (1997) Iset Clarida, Gali and Gertler formulation – equation (5). In line with Clarida Gali and Gertler forward-looking for Wohar Iuse As Taylorrule, practice and (2002)). (seeSiklos equation with (5) Taylor rule with contemporaneous which corresponds smoothing, For errors. (HAC) standard consistent autocorrelation and heteroskedasticity Newey-West (OLS)with Squares Least I useOrdinary rule contemporaneous in Appendix. Graph1and 2plots mainthe variables against time. description is 1 The intable data summarized example (2000)). Gertler Gali and Clarida, for (see stationarity assume most authors tests root of unit power low and sample Becauseof short has ignoredthe in beenlargely literature. issuethe nonstationarity of Nevertheless, (2004)). Wohar and Siklos (see variance infinite have to implausible is it sincerate, ininterest root of unit explanation problems are economic with there Moreover be notvalid.and and Fwill t willbeinconsistent statistics vector parameter estimated may andthen yieldintegrated 1levels results of spurious variablesorder are regression if well-known: are root unit estimating of problems The test. Fuller Dickey Augmented non-stationary. Except for Hungary monthly frequency, where ADF test cannot reject the null of non-stationarity in of non-stationarity null the reject cannot test ADF where frequency, monthly Hungary for Except 0). This seems reasonable, since policy makers generally are not concerned arenot with generally makers 0). Thisseemspolicy since reasonable, m =0 I use OLS as well with Newey/West standard errors, in line with common The interest rate and inflation for almost all countries in my sample are found are sample my in countries all almost for inflation and rate interest The I estimate contemporaneous lookingand forward For Taylor rules. 4 The output gap is The gap output stationary, byconstruction is and this confirmed by 11 k= 12 and k =0 CEU eTD Collection the real effective exchange rate (REER) rate exchange real the effective Iuse exchange rate For real main variables. as variables values additional the lagged of listnot the report instrumentequations,results. Ido Iexpand the numberof same with used monetary aggregates – m3,butenter significantly it since not inbaseline did the term. error the forecasting to for bankcentral is inflation anduseful isexogenous t, attime potentially ingap and isset of rate. Eachvariable information the interestthe inflation, output exchange rate in equation exchange rate the (2): estimates. consistent produce can matrix covariance weighted Newey-West with estimator errors the composite disturbance term disturbance composite the errors equation (5) using GMMin Because line with authors. of nature forecastoverlappingof GDPgap,which policy reacttocurrent the makers again seems reasonable. considerchanges in REER (as Mohantyin Klayand (2004)). adjusted forthe effects of inflation. I use levels as suggested by Taylor. The estimations stays robust when I 7 when using QS kernel and fixed bandwidth. robust largely are results The convergence. fast ensures and estimator GMM consistent autocorrelation Bartlett kernel, Newey Westbandwidth and no prewhitening, since it gives heteroskedasticity and least squares, when the model isoveridentified. I rely onEviews 6with this and all otherestimations. Iset 6 bellow. them report do nott I hence affected, 5 k= inflation resultsmonthly from the frequency horizon as well quarter one targeting (for used by Clarida, Gali Sauerandand (2000), Gertler Sturm (2003) andothers),Iestimate The weighted average of a country's currency relative to an index or basket of other major currencies major ofother basket or anindex to relative currency ofacountry's average weighted The Theprocedure as mentioned inClarida, Galiand Gertler(1997) will be atwo step non-linear two stage When I introduced a 3 month forward looking component in GDP gap, the results were not significantly 3 and 3 I also expand by the parameter vector includingexchange Additionally rate. I Taylor (2001)emphasized for the analysisusefulness including when the lag of m= 6 Iuse instruments from informationsetthe of central bank, namely 12lags of 0 in equation (5)) and report them if they offer different insight. Iassume that 7 of analyzed of the countries. H 12 will follow MA(k) process, then GMM 5 Iestimate CEU eTD Collection where follows: as canbe summarized he proposes “Therulethumb” of exchange rate.” current to the reacting simply than dynamics complicated more slightly for allows rate exchange lagged that Note means appreciation. 4. 3. 2. 1. I utilize the formulation above in forward looking Taylor Rule (3) as well: targeting. rate summarized asexchange be can Thiscondition arelarge persistent. exchange and to rate shocks the This implies the orthogonality moment condition (5) will have following form: following have will (5) condition moment orthogonality the implies This Taylor (2001, p.Taylor (2001,4)in line with Obsfeld andRogoff “The that(1995) argues s offsetperiod; next policy”; monetary “relaxing calls Taylor which rate, interest term short lower to bank J J J J t 1 1 1 1 is REER at time at REER is <0 and <0 and <0 and <0 and <0 iys ss Ey ii ii E yss i  ktt t t t tm t tk t tttt t kt t tk tk t *** 1)() ) (1           :ª :º  J J J J 1 2 (1) (1) (1) (1) (1) PMSEGG 2 =- 2 <0, then central bank gives high weight to exchange rate stability and stability rate exchange to weight high gives bank central then <0, >0, but UJUH =0, then higher nominal real exchange rate would call on central J M EUJ UE UMS S M U SS JJ SE MS 2 211 () , then interest rate reacts to the change in exchange rate; in exchange change to the rate reacts interest , then Li s ^ tt t  ** ^ t and J 1   DS P + { J s 2 r t <0, then initial interest rate reaction bepartially reaction will rate initialinterest <0, then  ` ** 21 1 1 the same a period earlier. The increase in REER in increase The earlier. a period same the ` t (8) and 13  (6) MD ¬¼ { 1 ,1 , . 21 1 (7) CEU eTD Collection However, standard errorsshouldHowever, standard be valid eveninsimple model. Unit The root is another which accounts for serial correlation of unknown form, this is no longer estimation, GMM In a problem.models. simple the with issue an isstill correlation serial significant for accounting serial errors correlation the standard Newey-West and heteroskedasicity, estimation by Although rulesTaylor difficulties of Carareand (2005)). Tchaidze I use problem has interesting plagued estimation that (See an the Taylor-type of review rules is common themost Serial are severedcorrelation correlation. byserial (2)) (equation both both monthly the frequency forand quarterly analyzedcountries: and rate. current lagged exchange weights to give zero reality can in economies in open rules policy optimal the because misleading, be can terminology as rate exchange x x x Before presenting the results, itmust be noted that the estimates of the simple rule frequency and equation (8) respectively, where respectively, equation (8) lookingforward Taylorrule andits open economy version (5)and (equations I will refer, from now on, to the Taylor-type rules that consider explicitly (equation andrespectively, (equation (5) equation both (8) where version economy open its and smoothing with rule Taylor contemporaneous respectively); (5) simplethe open version andits (equation Taylor rule economy equation (2) and for functions reaction policy following of the estimates Ireport section In this open economy Taylor rules, m IV. The Estimation Results is set to 0). k isset 12formonthly to and 4 for quarterly 14 for the sake of forthe sakeof convenience, although such k and m is set to 0); CEU eTD Collection of value the Itis that remarkable 2000). and Gertler Gali (Clarida, changes inexpectations in output that result fulfilling possibility the burstinflation open self the to of of and leave which is to the economy argued “accommodative”policy, monetary CNB avoids fall. behavior the interest rate By this let term not to realshort enough inflation the just risein of of expected rates interest response nominal the raising analyzed period, the during marginally principle Taylor the followed CNB the that stating remarkable, significant. is rarely but well, as gap hasformostequation significantly. output casesthe expected coefficient sign the In inthe sign andalwaysenters expected has forin inflation, allspecifications, coefficient parameters: sample spanning period the January 1996 -January of 2009. The estimates the cannot account for the structural break. structural the for account cannot 9 Gertlerand (2000, p. 154).Many authors avoid problem the by not mentioning it at all. postwar US, although“the null of unit root in eitherof the variables is often hard to reject.” Clarida, Gali 8 levels. significance conventional with specifications the in all 1 from rejectthat cannot test restriction Wald coefficient Moreover, little. am considering. I sample short the for assumption reasonable seems it since authors, other with along series, the of stationarity the assume I rate, interest in root presenceunit of reject the cannot standard tests fact that the issue: despite problematic Especially the forinflation targeting period itis hard to explain the presence of unit root,where one Clarida,Gali Gertlerand (1997, 2000) consider stationarity of inflation andinterest rate reasonable in M is near unity in almost all the specifications: the average The findings about monetary policy of the Czech Republic are somewhat are Republic Czech the of monetary policy about The findings I estimate the monetary policy reaction function for the Czech Republic inthe for theCzechRepublic function reaction policy monetary the I estimate P , M , E , J 1 , J 2 A. The CzechRepublic and U for the whole sample are reported in 15 M is 1.06,varyingvery M is not different not is 9 table A . The . 8 CEU eTD Collection * Sample 1996-2001. covariates. * Forward looking model target is one-quarter-ahead inflation. Here the instruments are four lags of the ** reject thatoveridentifying restrictions can’t are J satisfiedtest Hansen at any conventional respectively. lags significance four frequency levelquarterly forall for GMM.REER; economy, ofopen case the in set instrument variables include the GMM constant, In model. for the monthly improves frequency: parameter twelve smoothing lags Hence oflags. 5 inflation, within output LM test gap and, Breusch-Godfrey smoothing rate theinterest null of with no models serialthe correlationin cannot however, be rejectedcorrelation; conventionalserial significance of positive degree levels by high with characterized are of regression linear for coefficients givenp-values for Wald test (F-statistic) that parenthesis are givenp values (t statistic). Formodels withinterest rate smoothing inparenthesis are Forward lookingNote: models are GMM,Looking TR OLS. For GMMForward 1996 year Economy sample is lost.Open For simple models in Looking TR Forward Smoothing Interest with Economy TR Open Smoothing Interest TR with Simple TR Economy Open Simple TR fortheCzechRepublic A.Taylor-typerulesestimation Table )/(1( )0 EU , ***  { c M-monthly: Sample spanning 1996:1-2009:1. Q-quarterly: sample spanning 1996:1- corresponds respectively to 10%, 5% and 1% significance level. 1%significance 5% and 10%, to respectively corresponds y Freq. M.** Q.* M. M. M. M. M. M. Q. Q. Q. Q. Q. Q. , )/(1( )0 JU 13.03*** 12.45*** 1 13.7*** 11.4*** 12*** (.00) 48.7*  { (.00) (.00) (.07) (.00) (.00) (.30) (.34) (.65 (.29 (.12) (.74) (.98) (.30) 2.41 0.99 0.55 0.68 3.77 0.15 0.03 0.51 P c s ) ) t S ttt t ,, , 0.89*** 1.01*** 1.13*** 1.01 1.19*** 1.04*** 1.06*** 0.97*** 1.24*** 0.82** 0.70** 0.85** 0.98** yss (0.06) 0.65* (.02) (.00) (.00) (.00) (.00) (.00) (.02) (.00) (.00) (.00) (.00) (.00) (.03) M ***  , 1 0.66*** 0.31*** -0.65** /(1 ) ( )0 respectively and respectively 1.09** 16 JU 0.11* -0.56 -0.11 (.00) (.00) (.07) (.00) (.02) (.19) (.29) (.20) (.21) (.66) (.22) (.27) (.76) (.29) 0.35 2.09 0.20 0.15 0.22 0.16 0.59 2 E  { )/(1( )0 PU c s t  {  1 -0.21*** -0.19** -0.30** 0.28** (0.08) c 1.07* -0.38 -0.40 (.02) (.00) (.02) (.00) (.13) (.20) (.13) 0.26 J ------1 c isaconstant. The simple models 0.20*** 0.11** -0.29 -0.29 (.00) (.01) (.02) (.27) (.22) (.11) (.26) (.31) 0.28 0,09 0.61 0.32 ; where J ------, 2 )/(1( )0 MU (0.70)***  { 0.90*** 0.73*** 0.91*** 0.85*** 0.89*** 0.96*** 0.72*** 0.96*** cccc (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) S 0.62 U c ,,, - - - - S yss tt Adj. 1998:4. R 0.97 0.96 0.89 0.95 0.97 0.94 0.94 0.89 0.90 0.97 0.64 0.72 0.93 0.97  1 2 are * , , CEU eTD Collection beyond 90%in monthly specifications and above 50%in quarterly specifications generally. 11 offered. cure formal no and literature the in unexplored largely 10 Forexample,period. forward-looking inflation with the model one-quarter–ahead targets following in the offset fully is almost reaction initial but policy, monetary loosening by REER rise of reacttothe theCNBdoes that suggest specifications model the majority of instruments. in changes slight to robust now is model the Moreover, signs. expected the with coefficients significant very statistically change thetargethorizon inflation of with inflation Iget one-quarter-ahead target, specification. GMM the of in any valid not are restrictions overidentifying that ahead inflation targets are very unstable in this sense. Yet, the Hansen J test cannotdetect lagsof used. instruments the of coefficients. It is known that the estimates rate exchange of real the GMM for are signs sometimes non-intuitive has sensitive regression same The to the illusion. order statistical a just be could it sample, small the account into taking However, policy. monetary which is negative This andsignificant. would suggestthat the CNBfollows a pro-cyclical value of muchpositivecompound innotline weight, with thepattern theory.the Does to the looking GMMmodel in frequency. monthly Theestimates withare significant, little cases contemporaneous a possible consensus of a little positive weight on the output gap. In the most The P value of the test is far from rejecting threshold (1-10%) in all specifications, generally being Thisproblem ismentioned by Siklos andWohar (2004) and Carare and Tchaidze (2005), although The model specifications give result for parameter giveresult specifications The model Another interesting finding concerns the dynamics of targeting. The findingexchange rate of the dynamics concerns interesting Another E in the open economy forward looking Taylor rule in quarterly frequency, inquarterly rule forwardTaylor looking in openeconomy the E is insignificant. However, insignificant. is 10 The estimates from quarterly sample with one-year- sample with from quarterly Theestimates 17 E enters significantly in forward in significantly enters E with less synchronicity, with 11 When I CEU eTD Collection equilibrium exchange rate when rate exchange equilibrium very very suggestingsignificant, behavior: smoothing significant that betweenonly 30 20 to present. of the than rather of past the matter was changes rate exchange on the reaction the that during thesample of insignificant1996-2000 and was in 2000, periodthe after suggesting high significant was and exchange rate on policyreaction the that confirmed smoothing interest both and with models contemporaneous rate exchange rates: forward-looking commitments. bankitsfrom anti-inflationary of deviation central the will be interest ratewillbetemporary andonly afurther decreaseof regardedas by justified however,impact Taylorthe rule; inflation the of currency appreciation on monetary loosening the exchange drives be downthe inflation of rate policy rate, the will real of the appreciation the Since inflation concerns: of effect the trace can one offsetting, Asfor(partial) rational of domestic ones. than cheaper becomesince they relatively foreign goods of is increaseof later attractiveness duetothe the of appreciation; effect contractionary the mitigates rates interest cut of the is that response for negative reason longinimplying points,point arate.The run 1.1 percentage interest percentage cut the interest rate by 2.1 percentage points, which will be partially offset in following period by implies appreciation infor that 10percentage REER points would callonthe of cut very high. very are estimates rate exchange real equilibrium inRepublic Czech the that A suggests table Note that parameter that Note regarding dynamics interesting more some gave subsamples the of Analysis The Finally, the estimates of smoothing parameter ofsmoothing estimates Finally, the P equals M is not significantly different from 1. In the case the i **  18 1) ( MS t and hence is approximately real approximately is hence and U are very high and statistically CEU eTD Collection Republic, but has the expected sign and is always significant. Interestingly enough Interestingly significant. is always and sign expected the has but Republic, she assumes that the MNB reacts gap. andinflation MNBreacts on the that expected she assumes output the if gap; policy monetary MNBfollowsand that the “active” and canconclude output inflation is reactingon contemporaneous MNB the that ifsheassumes policy monetary “accommodative” the MNBfollows the concludemight that one paper, the finding of interesting more one implies result This isused. specification forward-looking the when unity the above is and is used specification contemporaneous the when unity the bellow sample are reported in the for thefull endof estimates parameters the the beginning at2008.The of 1996 ending of banks smooth interest rates. This pattern is maintained in other countries as well. quarter of the change. Hence itis the strong support of the hypothesis that the central within the rate interest term in short isthe reflected target rate in interest change percent parameter, and the output gap coefficient is never significantly different from zero. smoothing large very a give and unstable are GMM with estimates monthly the Yet, monthly models: The quarterly negativemodels report sign themonthlywhile – positive. and quarterly sophisticated more the between arises confrontation Interesting correlation. rule model, four which counts on from eightreported negative signs, is flawed byserial Taylor simple the However, policy. monetary pro-cyclical follows MNB the that suggest In the case of I estimate the Taylor-type rules in Hungary for the period starting from the The value of The value M E displays much more variation than in the case of in Czech caseof the the than variation more much displays the negative signs are prevalent, often significant. This can This significant. often prevalent, are signs negative the table B . B. Hungary 19 M is CEU eTD Collection instruments are four lags of the covariates. ofthe lags four are instruments * Forward looking one-quarter-aheadmodel is target inflationcontemporaneous and outputgap. The overidnetifying that rejecting restrictionsfrom far very are satisfiedis J test againHansen at any GMM model.respectively. lags four frequency quarterly for REER; economy, variables include constant, formonthly frequency: twelve lags of inflation, output gap and,problems in the of case serial from of correlation. free open are Hence smoothing smoothing rate interest parameter improvesincorporate which themodel. models the In in GMM the set correlation; instrument serial ofpositive degree regression of regression Wald test(F-statistic) that are givenp-values (t statistic). For models withinterest rate smoothing in parenthesis are givenp-values forlooking models are GMM, others OLS. For GMM 1996 year sample is lost. For simple models in parenthesis Note: Looking TR Forward Economy Open Looking TR Forward Smoothing Interest with Economy TR Open Smoothing Interest TR with TR Simple Economy Open TR Simple Table B.Taylor-type rules estimation for Hungary )/(1( )0 *, **, *** JU 1  { M-monthly: Sample spanning 1996:1-2009:1. Q-quarterly: sample spanning 1996:1-1998:4. Forward c s t corresponds to 10%, 5% and 1% significance levels respectively. levels 1% significance and 5% to10%, corresponds S ttt t ,, , yss Freq. Q. M. M. M. M. M. M. Q. Q. Q. Q. Q. Q. * , /(1 ) ( )0  JU 1 3.14*** 0.88*** 4.96*** 13.77** 3.94*** 2 1.36** respectively and respectively 10.04 -3.48 (.04) (.00) (.00) (.00) (.00) (.00) (.11) (.57) (.80) (.99) (.51) (.51) (.35) 6.39 4.54 0.01 5.18 0.94  { P )/(1( )0 c PU s t  1  { c 1.40*** 1.25*** 1.12*** 0.72*** 0.62*** 1.02*** 0.74*** 1.05*** 1.04*** 0.64*** 0.73*** 0.90*** 0.62** (.01) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) M c is a constant. The simple models are characterized with high with characterized are models simple The constant. a is ; where 20 -0.36** -0.27** 0.67** -0.58* -0.58* , (0.15) (0.12) 0.91* -0.82 -0.36 -0.68 -0.99 (.08) (.02) (.00) (.01) (.81) (.23) (.31) (.81) (.73) (.02) (.02) 0.37 0.27 0.61 E )/(1( )0 MU  { c cccc S S 2.06** 0.83** ,,, -1.19* -0.19* -0.35* -0.09* (0.08) -0.15 (.08) (.06) (.06) (.00) (.05) (.29) J yss ------1 tt  -2.11*** 1 -0.91** 0.41** 1.19* are coefficients for linear for coefficients are -0.21 (.03) (.03) (.00) (.09 (.13) (.31) (.76) , 0.11 0.02 J ------2 ) )/(1( )0 EU  { 0.94*** 0.81*** 0.85*** 0.97*** 0.94*** 0.96*** 0.88*** (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) 0.79 0.79 c U y - - - - 0.98 0.96 0.95 0.97 0.98 0.97 0.95 0.97 0.94 0.96 0.92 0.94 0.91 R Adj. 2 , CEU eTD Collection output gap. the to weight positive a slight gives NBP the is that impression overall The positive. in morespecifications reliable However, serial correlation. inflation. rising the contains and thus riserates real the to enough rates nominal the itadjusts inflation: controlling for policy monetary active runs that countries targeting inflation of all cases but one, implying that the NBP is the only central bank from the analyzed group in from one different not are estimates the that rejects test restriction Wald coefficient the specifications, and all themof come with expected sign and all are significant. Moreover, in reported 1. table inflation forhence onlyparameters contains are of estimates period targeting. The the considerations. rate exchange significant with targeting asinflation be summarized Hungary can of policy looses The monetary significance. coefficient exchangethe rate 2002, after period the when considering Yet Republic. case the Czech of the to and similar much findings authors (Mohanty of other (2004)andand Claw (2006)) andSchobert Frommel (+/-15) againstEuro was maintained until endof the 2008. Theresultis in line with the Forint of peg wide the since surprising not are results The rate. exchange in movements The estimates of The estimates The coefficient for The coefficient of The estimates Due to the data limitation, the estimation sample of Poland starts in limitation, of 1998 and Poland estimation starts sample data the Due tothe J E M 1 and has significantnegative valuesin simple models plagued by are much in line with each other across model the across in lineeach muchother with are J 2 imply that the MNB still reacts directly on the C. Poland 21 E enters significantly only if only significantly enters CEU eTD Collection p-values forWald test (F-statistic) that parenthesis are givenp-values (t statistic). For models withinterest rate smoothing inparenthesis are given looking models are GMM, others OLS. ForGMM 1998 yearsample is lost. Forsimple models in Note: TR Looking Forward Economy Open TR Looking Forward Smoothing Interest TR with Economy Open Smoothing Interest TR with Simple TR Economy Open Simple TR Table B.The Taylor-type Rules Estimation for Poland the instruments are four lags of the covariates. * Forward looking modeltarget one-quarter-ahead when is inflationcontemporaneous and Here outputgap. at level. satisfied are significance any restrictions overidentifying that reject cant J test Hansen the respectively. lags four frequency frequency: twelve of lags inflation, output gapand, inthe case ofopenmonthly economy,for for REER;quarterly constant, include variables serial instrument of no set the In GMM null 5%. the at be rejected frequency not can monthly at correlation frequency, quarterly at correlation of serial from suffer rate smoothing interest incorporate which models the in correlation; serial positive of degree high with characterized of regression linear for coefficients )/(1( )0 EU  { M-monthly: spanning Sample 1998:1-2009:1. Q-quarterly: spanning sample 1998:1-1998:4. Forward c y Freq. Q.* Q.* M. M. M. M. M. M. M. Q. Q. Q. Q. *, **, *** , )/(1( )0 10.21** 15.72** 8.41*** 2.86*** JU 1.36** 9.26** 1.45* -3.02 (.08) (.04) (.03) (.03) (.04) (.00) (.00) (.00) (.63) (.32) (.28) (.16) (.70) 1 0.66 4.55 2.38 0.15 0.90 P  { corresponds to 10%, 5% and 1% significance levels respectively. levels significance 1% 5% and to10%, corresponds c s t S ttt t ,, , 1.71*** 1.61*** 1.82*** 1.91*** 2.30*** 1.35*** 1.40*** 1.43*** 1.48*** yss 1.52** 1.06** 0.28* 0.88* (0.8) (.00) (.00) (.05) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) M  1 , respectively and respectively 22 -0.62** /(1 ) ( )0 0.34** 0.36** -0.11* -0.11* (0.79) JU 0.12* (.17) -0.46 -0.31 -0.09 (0.7) (.02) (.06) (.06) (.02) (.02) (.26) (.22 (.55) (.36) (.80) 0.35 0.10 0.72 0.30 2 E  { ) ) )/(1( )0 PU c s t   { 1 c -0.81* -0.01 -0.05 -0.19 -0.05 -0.10 (.09) (.99) (.33) (.34) (.14) (.53) (.45) 0.43 J ------c 1 is a constant. The simple models are -0.53* ; where (0.10) (.06) (.36) (.44) (.44) (.93) (.77) 0.55 0.12 0.03 0.15 0.00 0.03 J , ------2 )/(1( )0 MU 0.90*** 0.76*** 0.77*** 0.88*** 0.96*** 0.92*** 0.90*** 0.90***  { cccc (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) S 0.76 U c ,,, - - - - S yss tt 0.96 0.92 0.96 0.96 0.97 0.87 0.98 0.98 0.84 0.86 0.83 0.98  R Adj. 1 are 2 , CEU eTD Collection the Coefficients are given in given are Coefficients the of limitations. Estimates due toof data from 2001 frequency, Iestimate As for quarterly thus highavoiding volatility inflation the of1996-98,which mightperiod bias results.the targeting”. monetary policy of Poland canbe most closely summarized by label “the pureinflation The one. potential the from output real deviation the extent some to and expectations Poland is closer to those of closed economies, considering domestic inflation of function reaction the function. Hence, inits reaction explicitly rate exchange consider yields statistically significant estimates of estimates significant statistically yields model inflation target only monetary one-quarter-ahead policy.procyclical the However, pursuing of from allegations the RNB frees the which in specifications, sign all expected short term interest rate within a quarter from from within change. rate a quarter interest term short quarterly frequency,indicating 40-50%of target is around rate in interest the reflected in smoothing analyzedcountries is averageof the lower than the rate interest degree of simple Taylor rule model), although almost always correctly signed. The indicator of economy for theopen (except insignificantly in enters regressions the rate Exchange The not. parameter or policy “accommodative” whether RNBpursued the significant, vary it specifications,make reach considerably through difficult consensusto The estimates of parameter of The estimates themonthlyFor frequency of Romania Iestimate theperiodfrom starting 1999, The table C is unambiguous exchange with rate: NBPdoesnotthe regards to table D. M D. Romania , although in signas expected all cases with and 23 E apart from the simple Taylor rule models. rule Taylor simple the from apart E has CEU eTD Collection where Looking TR Forward Smoothing Interest TR with Open Economy Smoothing Interest TR with Simple TR Open Economy Simple TR D.Taylor-typerulesestimation forRomania Table of the covariates the of lags four are instruments the Here inflation. quarter-ahead a is target the when frequency Quarterly * respectively. levels significance 1% and 5% smoothing in parenthesis are givenp-values forWald test (F-statistic) that lost. Forsimple models inparenthesis are givenp-values (t statistic). For models withinterest rate Forward looking models are estimated are GMM, others are OLS. For GMM the firstyear sample is Note: Looking TR Forward Open Economy Hansen J test can’t reject that overidentifying restrictions are satisfied. are restrictions overidentifying that reject can’t J test Hansen gap and, the incase of openeconomy, REER forquarterly frequency fourlags respectively. The the set instrument variables include constant, formonthly frequency: twelve lags of inflation, output frequency, at monthly modelsfrequency which incorporate the in interest rate smoothingcorrelation; suffer serial fromof positive of serial correlation degree the high with atquarterlynull characterized are models simple ofThe constant. a no serial correlation can not be rejected at 5%. In GMM )/(1( )0 MU  { c M-monthly: spanning Sample 1999:1-2009:1. Q-quarterly: spanning sample 2001:1- S cccc S ,,, yss tt  1 , Freq. are coefficients for linear regression of regression linear for coefficients are Q.* Q.* )/(1( )0 M. M. M. M. M. M. Q. Q. Q. Q. EU  { c 34.62*** 5.51*** 0.46*** 20.27** y 29.25* -3.09 (.07) (.00) (.90) (.00) (.00) (.00) (.53) (.22) (.18) (.55) (.23) (.55) 3.44 1.13 8.61 0.52 3.86 1.28 P 1.17*** 1.22*** 1.28*** 0.61*** 0.94*** 0.92*** 0.86*** 0.97*** 0.65*** 1.45*** 1.37** 0.50** (.00) (.00) (.00) (.01) (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00) M , 24 )/(1( )0 JU 1 1.65*** 1.53*** 0.33***  { 0.25* (.06) (.00) (.00) (.27 (.35) (.23) (.21) (.52) (.46) (.53) (.17) (.00) 1.11 0.97 0.58 1.05 0.17 0.20 0.46 0.69 c E s t ) S -0.35** ttt t (0.16) -0.23 -0.04 -0.48 (.01) (.54) (.82) (.38) ,, , (.76) 0.15 -41 yss ------J *, **, *** 1 , /(1 ) ( )0 0.27** JU  (.02) (.57) (.86) (.34) (.35) 0.22 0.03 0.51 0.13 0.22 (77) 1 2 ------respectively and respectively )/(1( )0 J  { PU corresponds to 10%, 2  { c s t 0.64** 0.59** 0.96** 0.94** 0.94** 0.47** 0.99**  c 1 (.00) (.00) (.00) (.00) (.00) (.00) (.00) (.12) 0.56 U * * * * * * - - - - 2008:4. R 0.96 0.98 0.98 0.87 0.98 0.96 0.94 0.91 0.94 0.81 0.97 0.92 Adj. c 2 is ; , CEU eTD Collection up conflicting results and limits the emergence of limitsup conflictingmore thespecificconclusions and of on the results emergence interpret makes the popped forto occasionally hard although somefood generalizations, illustrate problem the estimation agood gives andEuropean of isuseful countries, to rate. exchange followingtargeting: started Taylor the reacting principle andstopped directly on “relaxingthe butchanged monetary policy”, the policy drastically adoptingafter inflation LM test. toBreusch-Godfrey according correlation ofserial problems from free are estimations of regression linear for coefficients are givenp-values for Wald test (F-statistic) that Note: Post-IT Pre-IT Period Table E.Comparing pre inflation targeting and post inflationtargeting Taylor rules. Taylor rule that accounts for interest rate smoothing. The results are given in targeting 2006-2009subsamples andestimate them with openeconomy contemporaneous inflation inflation Romania.pre sampleinto 1995-2005andpost targeting the Idivide )/(1( )0 EU  { Pre-IT 1996:1-2005:1, Post-IT; 2005:1-2009:1. Equations estimated areOLS. in parenthesis are c y The analysis of subsamples gives useful insight in the monetary policy of policy monetary in the insight useful gives subsamples of analysis The The variety of Taylor-type rules, I estimated for the four Central and Eastern wasfollowing targeting inflation NBRbefore The arestriking. The differences (.40) 7.04 (.00) 59.1*** P , (.01) 1.28** (0.18) 0.29 M )/(1( )0 JU 1  { c s t (.76) 0.01 (0.14 1.05 E E. Summing Up S ttt t (.84) -0.02 (.02) - ,, , J 3.20** yss , 1 25 /(1 ) ( )0 JU 2 )/(1( )0 PU  {  1  { c respectively and respectively (.32) -0.08 (.40) 0.27 s J t c  1 2 (.00 0.90*** (.00) 0.94*** U ) , ; where )/(1( )0 c MU is a constant. The  { 0.97 0.98 Adj. R c S cccc 2 S ,,, table E. yss 1.98 1.95 D W tt  1 , CEU eTD Collection monthly; Q :k=1, m=0 – Quarterly, with targets: one-quarter-ahead inflation, contemporaneous output gap. Economy TaylorRule (with interest smoothing); TR – TaylorRule (withinterest smoothing); M – Note: Romania Poland Hungary Republic The Czech variable. lagged of values endogenous the which real takes forecast static powerful tool than Itismore forecast. variables generate independentto valuesof andthe variable real valuesin and differentperiod solved needs starting henceonly of point endogenous it variable the bindsto thelaggedendogenous is essence of forecasting that dynamic power of the the forecasting investigate Forthis better? I themonetary policy characterizes estimated, derived modelsmentioned forthe overcome to way a eachand analysis, of continuation logical The policy. limitation,monetary country. I use isthe to dynamicaddress forecasting. the question: The what type of rules, from the ones Country Table F.The withbest models forecasting power countries. analyzed the monetary of policy the RMSE –Root-Mean-Square-Error; OEFLTR –Open Economy TaylorRule; OETR–Open (1) conclusions: interesting leadtosome The results Table F. Q. OETR,OLS, M. TR, OLS, M. OETR, OLS, m= GMM, Q,: k=OEFLTR, horizon Method, Specification, shows the models which have the best forecasting power in forecasting power besthavedescribing the showsthe models which inflations and output. The coefficient The output. and inflations for weights positive defined well with rule aTaylor follows Poland 0 1 , (.53) 3.44 (.00) 0.90 (.51) 5.18 (.00) 13.7 P (.00) 1.17 (.00) 1.40 (.00) 0.72 M (.00) 1.01 26 (.27 1.11 (.02) 0.36 (.23) 0.37 (.00) E 0.66 ) (.54) -0.23 - (.08) -1.19 -0.21 J (.00) M 1 is significantly above unity, above issignificantly (.57) 0.22 - (.09 1.19 J (.02) 0.11 2 ) (.00) 0.94 (.00) 0.59 (.00) 0.90 U (.00) 0.62 1.31 1.53 2.05 1.60 RMSE CEU eTD Collection the dynamic forecast of estimated Taylor rules capture all Taylor of forecast dynamic of the capture short rules points turning estimated the the possibly well,of except caseof and Poland The Romania. since Hungary areremarkable, the describe in the proposed rules the simple that that indicate figures The rate. interest actual The figures from (4) (3) (2) historic path of the monetary policy rate remarkably of countries respective monetary policy rate of historic path the interest rate. interest Romaniafollowsmaking emphasis principle, general Taylor on It strongly reacts to interest rate and fully offsets next period. from sample. the policy monetary “accommodative” tothe close most Republic, is isless The country although concernedwith output. the To some extend Hungarywhich Taylorlabeled “the partial offsetting.” has somewhatdynamics to close most rate exchange real in the movements similarthe to policyreacts and output of variation the with as concerned is strongly It thepolicy. Czech monetary accommodative thusavoiding constant, interest real the The Republic followsCzech marginally,leaving Taylorthe principle 2 -the values (1993)assumedTaylor in originalthe rule; Taylor to near very be will rate interest equilibrium real the then rate, inflation 2,rate equal as to a real equilibrium inflation theirconsider target fromvariation responding its positively output to of trend. If we simultaneously while inflation contains and rates in real rates interest thus the National Bank of Poland translates the raise of nominal A1 to A4 bellow plot the Taylor-type rules forecasts against the 27 table F CEU eTD Collection tracks almosttracks one to one sincerate officialthe repo 2006. it mentioning: a separate Poland for isworth The suggested interestTaylor rule term rate. interest rates Figure A. Thedynamicforecast oftheestimated Taylor rules against theactual 12 16 20 10 15 20 25 30 0 4 8 5 97 1996 98 99 1998 00 A1. Czech Republic B B a 01 a n 2000 A2. Hungary n k k R R a 02 a t e t 28 e 2002 03 TR T 04 R F 2004 F o o r 05 e r e c c a a s s 06 t t 2006 07 2008 08 CEU eTD Collection 28 12 16 20 24 10 20 30 40 50 0 4 8 0 2001 98 99 2002 00 2003 R B e 01 a po A4. Romania A3. Poland n k 2004 R R at 02 29 a e te 2005 03 T TR R 04 F 2006 f o o re re c c 05 a a s st t 2007 06 2008 07 CEU eTD Collection useful useful hedge to from possiblethe misspecifications. comprehensive relying be approach, than estimation assumptions, onsingle rather can inhorizon targetthe of bank. central using methodproposed paper, the the The example in the case of Hungary, one gets the opposite results, based on the assumption of the short-term interest rates remarkably well. of historicthe track that record of parameters weights specific with analyzed countries, economies. large“closed” the thatof very to closed policy small,Poland evidence strong gives that open, emergingmarkets can have the monetary Yet, thecase by(2002). andReinhart of proposed floating”Calvohypothesis, “fear of tothe oriented inflation monetary oriented policy.All tothe givessomethis support as and policythe (2001), inTaylor illustrates shift Romania from exchangethe rates line Czechthe theory byObsfeld Rogoff offered Republic,in well and the (1995) as with and Hungary of banks central the by rate exchange on reaction policy direct of evidence monetarythe inflationpolicy of targeting emerging markets. The paper provides some into insight good a offer can rules Taylor-type the that conclusion the to leads that results assuming differentsample for central horizons bank Isuggestanumber of interesting and methods specifications, different By the using targets. inflation with economies This paper setout estimateto Taylor-type for rules four emerging European Lastly, itillustrates some estimation shortcomings of Taylor-type rules. For functional of Taylor specificrules the forms of Besides suggestthe the the paper V. Conclusion 30 CEU eTD Collection say: “Imight not have found the cat, but at least Iknow that it ThisEurope. is a fruitful field for future researches. optimal monetary inpolicy small, of markets open,emerging Central and Eastern the about evidence any provide not does and economy of movements the on banks central The limitation of the paper is that it traces the historical policy of responses policy theit historical traces is paper that of the The limitation Finally, the saying returning to mentioned of Confucius, inintroduction, Ican 31 is there for sure.” CEU eTD Collection Eastern Eastern Europe.” Frommel, Michael and Franziska Schobert.2006. “Monetary Policy Rules in Central and Central Bank of Chile, 117-67. and K. Schmidt-Hebbel (eds) Corbo, Vittorio. 2002. “Monetary Policy in Latin America in the 1990s”, in Loayza, N. Economics Macroeconomic Stability: Evidence and Some Theory.” Clarida, Richard, Jordi Gali, and Mark Gertler. 2000. “Monetary Policy and Evidence.” Some International Clarida, Richard, Jordi Gali, and Mark Gertler. 1998. “Monetary Policy Rules in Practice: Research,Bureau ofEconomic National Clarida, Richard. “The Empirics of Monetary Policy Rules in Open Economies.” them?” canweestimate Precisely Carare, Alina and Robert Tchaidze. 2005. “The use and abuse of Taylor Rules, How Journal ofEconomics, 114(2): 379-408 Calvo, Guillermo A. and Carmen M. Reinhart. 2002. “The Fear of Floating,” of Economics Bernanke, Ben S., and I. Mihov. 1998. “Measuring Monetary Policy”, 6760. Estimators.” Hansen, Lars. P., 1982. “Large Sample Properties of Generalized Methods of Moments Economics. Exercise in Estimation.” Working Paper, Financial Markets Group. London School of Goodhart, Charles A. E.2004. “The Monetary Committee Reaction Function: An Quarterly Bulletin, Goodhart, Charles A.E. 1999. “Central Bankers and Uncertainty”, Equilibrium of Nesting TaylorPaper. Rules.” Draft Gillman, Max,Kejak, Michael, Le, Mai Vo and Patrick Minford. 2008. “A General Ball, Laurence. 1999. “Policy Rules for Open Economies.” References: 115(1):147-180. Econometrica, 113 (August):869-902. http://ideas.repec.org/p/han/dpaper/dp-341.html 39 (February): 102-14 1029-1052. Monetary Policy rulesandTransmission Mechanisms European Economic Review European Economic IMF Working 05/145. Paper. Working Paper8603. 32 The Quarterly Journal of 42 (6): 1033-67.42 (6): NBER Working PaperNo. Bank ofEngland Quarterly Journal Quarterly ” CEU eTD Collection Unbalanced Regression.”Unbalanced Siklos, Pierre, L., and Mark E. Wohar. 2004. “Estimating Taylor-Type Rules: An The National Bank of Romania, http://www.nbp.pl/Homen.aspx?f=srodeken.htm The National Bank of Poland. Bank. National Czech The Monetary Models: Results from a New Monetary Database.” Taylor, John B. and Volker Vieland. 2008. “Surprising Comparative Properties of Review, American Economic Taylor, John B. 2001. “The Role of the Exchange Rate in Monetary Policy Rules.” http://www.stanford.edu/~johntayl/Papers/Bank%20of%20Mexico%20Paper2.pdf Taylor, John B. 2000. “Using Monetary Policy Rules in Emerging Market Economies.” (Ed.), Taylor, John B. 1999. “A Historical Analysis of Monetary Policy Rules.” In Taylor, J.B. Series onPublicConference Policy Taylor, John B. 1993. “Discretion versus Policy Rules in Practice Rule apattern?” Taylor Maria-Dolores, Ramon. 2005. “Monetary Policy Rules in Accession Countries to EU: Is empirical investigation.” Discussion paper 451,Carnegie-Mellon University Hodrick, Robert J.and Edward C. Prescott.1980. “Post-war U.S. business cycles: An Review, Federalreserve Bank ofKansas City. 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CEU eTD Collection Estimation.” Wooldridge, Jeffrey M. 2001.“Application of Generalized Methods of Moments Bank. The Magyar Nemzeti Journal of Economic Perspectives,Journal ofEconomic Official Website 34 . http://english.mnb.hu/Engine.aspx 15(4): 87-10015(4): CEU eTD Collection Table of 1.DescriptiveStatistics VariablesMain Std. Dev. Minimum Maximum Median Mean Std. Dev. Minimum Maximum Median Mean Std. Dev. Minimum Maximum Median Mean Std. Dev. Minimum Maximum Median Mean Inflation Inflation Iinflation Inflation The Czech Republic The 13.18 25.29 13.18 102.0 20.73 24.1 3.58 26.8 3.47 0.07 3.75 4.46 5.25 2.26 7.39 8.88 3.47 0.07 3.75 4.46 Romania Hungary APPENDIX Poland Rate Bank Rate Repo Rate Bank Rate Bank 5.818 12.52 13.34 26.17 5.88 9.71 34.1 5.88 9.71 28 11 6.5 6.5 35 24 58 24 6 4 7 4 GDPgap REER gap GDP gap GDP gap GDP -11.94 -11.94 -20.62 -0.04 -0.17 -0.04 -0.01 -0.12 3.55 9.16 0.33 4.86 17.5 3.55 9.16 0.33 3.56 7.68 -16 0 REER REER REER 135.93 105.54 135.93 105.54 10.84 104.9 58.26 148.6 100.4 103.2 10.88 104.9 18.30 91.25 162.3 117.8 116.6 88.7 21.3 88.7 CEU eTD Collection Graph 1. 10 15 20 25 30 12 16 20 -4 0 5 0 4 8 The co-movement of inflation and interest Rate 1996 1996 1998 1998 Inflation Inflation 2000 2000 2002 2002 36 Bank Rate Bank Rate Bank 2004 2004 2006 2006 2008 2008 CEU eTD Collection 120 160 200 10 15 20 25 0 5 80 40 0 97 1996 98 99 1998 00 Inflation 01 inflarion 2000 02 37 2002 03 Repo Rate Bank Rate Bank 04 2004 05 06 2006 07 08 2008 CEU eTD Collection GraphGDP Gap. 2. -4 -3 -2 -1 -10 0 1 2 3 -8 -6 -4 -2 0 2 4 6 97 1996 98 99 1998 00 The Czech Republic Czech The 01 2000 02 Poland 2002 03 38 04 2004 05 06 2006 07 08 2008 CEU eTD Collection -5 -4 -3 -2 -1 -1 -3 -2 0 1 2 0 1 2 3 2001 97 98 2002 99 2003 00 01 2004 Romania Hungary 02 2005 03 39 04 2006 05 2007 06 07 2008 08