EKONOMIE MONETARY RULES AND THEIR APPLICATION IN TIMES OF ECONOMIC CRISIS AND IN THE EURO AREA
Marianna Siničáková, Viera Pavličková
Introduction to the rate of growth of real GDP in economy. This rule was used in a certain form in the year Nowadays, the strategy of monetary policy 1935 already, when statistician Snyder [21] esti- application has become one of the most discu- mated a 4% growth rate of trade in the USA and ssed topics. World economic crisis helps experts stable velocity of money. Taking this information to realize that no existing tool is perfectly efficient. into account, he assumed that a 4% expansion of Therefore, they try to analyse which kind of mone- money per year will lead to the economic stabili- tary policy rules would be most appropriate. Both ty. Later, in the 1960s and the 1970s, Friedman, politicians and economists defend their opinions; himself, advocated the rate of growth of money either they support the discretionary policy or the supply of 4 %, which was equal to the level of eco- policy of the rule. nomic growth at that time. Discretionary policy means that the central Even more significant increase in the number bank does not follow any pre-determined steps of monetary rule followers came in the 1970s how to proceed under certain macroeconomic and the 1980s. It was the case of Kydland and circumstances. The greatest advantage is the fre- Prescott [5] for instance. They pointed out the edom in the process of choosing reactions to the problem of time inconsistency. A time inconsis- economic actions. tent policy can make the public happy, but only On the contrary, monetary rule policy can be in a short run. In achieving long-run policy goals, guided by some specific rule that must be follo- only time consistent policy can be successful. wed by the central bank. This leads to the confi- They offered the explanation by using the example dence within the relationship between the mone- of floods. Long term goal of the government is to tary authority and other economic subjects. prevent houses in areas threatened by floods. Po- liticians will inform people that they will not help 1. Rule vs. Discretion Discussion them financially in the case of floods. However, Until the 19th century, the discretionary strate- in a short run, if the disaster really happens, they gy was preferred by most of the countries of the will still support those who have suffered losses. world. No precise monetary rules were applied by Therefore, in any future case, people will not con- monetary authorities except the “gold standard” sider the government’s threat credible, if it did not and the exchange rate stability [15]. However, du- act according to its commitments. It will be more ring the last 100 years, monetary rules have found difficult for the government to influence people’s their followers. Good example of such a rule was behaviour if any problem occurs. In general, by the “gold standard”, where the unit of account is using the rules, the problem of time inconsistency a standard amount of gold. will be eliminated. Wicksell [21] brought a very simple rule, but Monetary policy rules defenders were also Bu- still, it was not widely spread. Paradox is that it’s chanan and Brennan [5]. They were convinced the most important disadvantage was its simplici- that discretionary policy enables a central bank ty. Many experts criticized the fact that the interest to generate inflation above its optimal level. Barro rate in the economy is only influenced by one pa- and Gordon [28] expanded this theory in the rameter – price stability. 1980s and claimed that monetary authority will al- Friedman’s k-percent rule is world known. The ways have propensity to lower the unemployment rule is also referred to as the „golden rule of mo- at the expense of higher inflation. ney stock growth“ [17]. Friedman claimed that the At that time, McCallum invented the so-called rate of growth of money supply should be equal McCallum rule [21]. The author focused on
strana 16 3 / 2011 E + M EKONOMIE A MANAGEMENT EKONOMIE monetary base as a central bank’s target. This In case that actual inflation rate exceeds the parameter is influenced by inflation rate, real target value, monetary authority should raise the GDP growth and growth of velocity of money. interest rate above its neutral value. Increase in McCallum claims the US economy would have interest rate will slow down the economic growth, achieved better results if it had followed his rule, raise the unemployment and inflation will get especially in 1930s and 1970s. back to its target. The rate of increase of interest In 1990s, monetary rules based on regulation rate is expressed by coefficient h, or a. of interest rate gained in importance. In 1993 J. On the contrary, a negative output gap (the B. Taylor presented a very easy monetary rule case when unemployment is higher than its na- which has become very popular immediately. Sin- tural value), the central bank should apply the ex- ce then, many countries all over the world have pansionary monetary policy and lower the interest applied this rule as a tool for monetary policy de- rate. This reaction will be followed by the rise of cision making process. the total product in the economy until it reaches its potential value. It will be connected with the 1.1 The Taylor Rule decrease of unemployment to the natural rate of unemployment. The author, J. B. Taylor, professor at the Stan- ford University, wanted to provide a very simple guideline for the monetary policy [25]. He fo- 1.2 Opinions of the Taylor Rule cused his research on the situation of the USA In general, the Taylor rule is considered to be and brought the equation that is now known and a supplement monetary tool to inflation targeting. applied by many countries all over the world. Eve- The rule focuses on achieving the inflation target rybody emphasizes its simplicity. The form of this in a middle-run. Moreover, it reacts to the GDP equation is: evolution that is closely connected to the inflation. i = Sgy + h (SS* r f (1) The Taylor rule is perceived very positively thanks to its intuitiveness, lifelikeness and simpli- i represents short-term nominal interest rate in city. In order to get the result, only data of actual percentage set by a central bank, S stands for the inflation and output gap are necessary. It descri- rate of inflation in percentage, S* means the infla- bes the policy applied in the past, as well as it pro- tion target in the economy, y is the output gap and vides certain guide how to proceed in the future. rf is neutral real interest rate that corresponds to The critics of this rule point out insufficient fle- zero inflation gap and zero output gap. Coeffici- xibility that ties banks´ hands. But, Taylor [1] him- ents h and g express the weights of both of these self defends his rule. He claims it is not determi- gaps. S*, r f, g and h are all positive values. ned absolutely and does not set the interest rate Other literature brings a slightly different equa- blindly. On the contrary, it reacts to the macroeco- tion [4]: nomic changes. One of the critics is Svensson [1]. He finds restrictive a very small number – 2 it = i* +a(StS* - b (utun (2) of parameters determining the monetary policy. It f where S plus r are replaced by one parameter, leaves no room for considering other information. that is i*. It expresses the target nominal interest Another important problem arises when we try to rate. The weights are a and b. The most important determine the exact level of neutral interest rate change here is the unemployment gap, which is and output gap or to choose the right set of data. used instead of output gap. As we know, higher During the past 20 years, practice has brought output is connected with lower unemployment some specifications of the Taylor rule in order to and vice versa. Therefore, the sign in front of this minimize the drawbacks. In general, we recogni- component is negative. se forward-looking and backward-looking Taylor Both equations claim, that if actual inflation rate rules. The former one uses predicted (ex-post) is equal to the target value and actual product rate values, while the latter one prefers actual data. has also reached the value of potential product The difference is visible on the example of the (output gap, or unemployment gap are zero), nomi- USA from 1997 [3]. Backward-looking rule su- nal interest rate set by the central bank should be ggested no change of the interest rate, but the equal to the target nominal interest rate (i , or + r f). t S forecasts-based one leads to increase in interest
E + M EKONOMIE A MANAGEMENT 3 / 2011 strana 17 EKONOMIE rate. Detailed analysis showed higher costs in the interest rate should reach the values of about case of keeping interest rate stable. Therefore, -5 % in these months. It is, of course, impossible the Americans [3] claimed forward looking rule to to implement in practice. As current federal funds be more convenient and efficient. This fact is also interest rate is 0 %, the difference between calcu- supported by the main goal of monetary policy, lated and real value is significant, i.e. 5 %. Fig. 1 which is to influence the future evolution, not the provides the review of this situation: present one. Taylor said, his rule showed that the FED´s However, Taylor himself vindicates monetary policy is appropriate [26]. However, he criticized rule derived from actual data, as his own rule was formula used by the FED. “They say they’re using originally formed this way [3]. He claims the rule the Taylor Rule, but they’re not.” While the co- helps economists to review the current economic efficients for both inflation and output gap in the situation and provides basis for future decisions. original Taylor rule are 0.5, the FED uses higher Moreover, he adds, the economists should not coefficient for the output. Moreover, Taylor works follow the rule mechanically. „...There will be epi- with actual data, as has been mentioned befo- sodes where monetary policy will need to be ad- re. However, the FED calculates this rule using justed to deal with special factors.“ [3] Neverthe- predictions. Based on the results, Rudebusch less, he sees significant advantage in using rules emphasizes necessity of other tools (to pump even in the environment, where it is impossible to money into the economy). On the contrary, Taylor be guided by them blindly. defends his rule as a convenient formula even du- ring the financial crisis. 2. The Taylor Rule and the Econo- mic Crisis 3. The Taylor Rule in Various Coun- We did not have to wait very long to confirm tries Taylor’s words. The economic crisis has not only Despite current discussion about applicability brought uncertainty and chaos to the entire world; of the Taylor rule during the world economic re- it has also discredited the reliability of the Taylor cession, it is still popular and adopted by many rule. Results of Rudebusch [26], vice-president of countries all over the world. As it was originally San Francisco’s National Bank, have shown that designed for the US economy, experts in other Fig. 1: Comparison of results of the Taylor rule and real interest rate in the USA from 1988 to 2010
Source: elaborated according [2] strana 18 3 / 2011 E + M EKONOMIE A MANAGEMENT EKONOMIE countries had to adjust it to their own conditi- Following part of the paper offers practical ons. For example, practice has showed lower applications of the Taylor rule in chosen count- interest rate variability than suggested by the ries and own calculation of a Taylor-Type rule for rule. Therefore, interest rate smoothing is used. Slovakia. General form of this alternative Taylor rule is as follows [1]: 3.1 The USA
it = Oit-1+(1-O)[i*+Y(St - S*)+E(yt-yt*)] (3) Originally, Taylor suggested the formula for the O represents interest rate smoothing coeffici- USA. Coefficients were based on empirical stu- ent, its values are from the interval [0,1]. It redu- dy; they were not econometrically estimated [25]: ces the interest rate volatility as the answer to the i = 2.0 + S +0.5 y + 0.5 (S - 2.0) (4) economic disturbances. Moreover, exact values Inflation target and real neutral interest rate of the parameters are never known, so it is not equals 2 %. Moreover, according to Taylor, both possible to estimate their influence on interest inflation gap and output gap have the same influ- rate precisely. ence on interest rate, therefore, both these com- Another change of the model in comparison to ponents have the same weights of 0.5 %. the original formula is a lagged parameter of inte- Mathematic interpretation sounds: If actual in- rest rate from the previous period it-1. Central bank flation rate equals the targeted one and the eco- expresses its commitment to change the interest nomy has achieved potential product, the real in- rate when inflation changes. If public understands terest rate is 2.0 %. For each percentage point by this commitment, central bank is able to influence which the inflation rises above (decreases under) the long-term interest rate by quite small move- 2.0 %, interest rate will increase/lessen by 0.5 ments in a short-term interest rate. percentage points. And each 1-percentage rise/
Fig. 2: Comparison of the Taylor rule results to Federal Funds Rate during the period of three FED governors – Burns, Volcker and Greenspan
Source: [12] E + M EKONOMIE A MANAGEMENT 3 / 2011 strana 19 EKONOMIE fall of output above its potential level means rise/ Following four years of Greenspan´s governan- fall of interest rate by 0.5 %. ce were under sharp critique. Taylor accused the Economic interpretation emphasizes that both FED of stimulating monetary policy too much that inflation and economic growth (respectively low have caused housing bubble. In the beginning unemployment) are two equivalent goals. This fact of year 2010, a vehement discussion has started corresponds to official announcements of the FED. after Bernanke, current governor of the FED and The Taylor rule describes economic evolution in superseder of Greenspan, defended the US mo- the USA during the past 30 years very truly, espe- netary policy in years 2002–2006. He pointed out cially since 1985. In periods, when real interest the differences between the Taylor rule results rate was equal to the one given by the formula, based on actual data and those based on predic- the economy was growing. On the contrary, du- ted data. While Taylor suggested contemporane- ring the years, when these values were different, ous values, the FED used forecasted ones. Fig. 3 macroeconomic parameters were not ideal. shows much stronger correlation between latter Fig. 2 compares the Taylor rule with federal data and federal funds rate than when calculating funds rate on quarterly basis from 1970 to 1998, with actual data. Therefore, the FED´s policy in the period of three FED governors – Burns, Volc- these years seems to have been appropriate. ker and Greenspan [12]. Taylor reacted to Bernanke´s speech imme- During Burns period, interest rate in the eco- diately [22]. He defended his opinion and clai- nomy was lower than that given by the formula. med that the deviation from the Taylor rule was Still, their evolution was highly correlated. These the largest since 1970s. He pointed out several years were connected with significant increase in problems and drawbacks of Bernanke´s analysis inflation. If the FED had followed the Taylor rule [22]. Firstly, the forecasted inflation used by the (with target inflation of 2 %), inflation would have FED in the Taylor rule was too low, because the been lower. inflation during the given period had increasing The period of Volcker brought opposite evoluti- trend. Secondly, there is uncertainty about the on. The figure shows interest rate moving under type of forecasted inflation. Beside the data that the level determined by the rule. These years the FED has used, there is also an average of pri- were also connected with a sharp reduction of vate sector inflation. However, the result will still inflation that was more aggressive than the one be „too low for too long“. Thirdly, Bernanke criti- suggested by the formula. cized the Taylor’s formula that it reacts to short- Greenspan´s period meant compliance of va- -term movements of inflation. Nevertheless, cu- lues in real economy and those calculated from rrent inflation measured by price indices avoids the rule. High correlation continued till 2002. this problem as well. Fourthly, Taylor disagrees Fig. 3: Comparison of the Taylor rule and The federal funds rate using inflation forecasts
Source: [22] strana 20 3 / 2011 E + M EKONOMIE A MANAGEMENT EKONOMIE with Bernanke´s statement about low statistical used McCallum and the Taylor formula based on relationship between the deviation from the rule quarter data as assistance by decision taking. The and the housing bubble. The OECD [22] has Taylor rule derived from British data from 1993 till provided this research and showed high corre- 2001 by Nikolov has taken on this form [19]: lation between these two variables. Finally, Taylor R = r ss + 1.5*(S – 2.5) + 0.5*(y – y* ) (5) thinks it is not necessary to observe his rule to t t t-1 t-1 t-1 ss conclude that federal funds rate was too low. The rt represents neutral real interest rate based real interest rate in this period was even under on indexed bonds. Output gap values move from zero, which supported borrowers and led to the 0.25 to 0.75. housing bubble. Comparison of the Taylor rule results and nomi- In conclusion, although Taylor considers Ber- nal interest rate is obvious from Fig. 4. nanke´s view wrong, he finds outburst of this de- Moreover, the Bank of England calculates the bate positive. The FED has started to analyse its so-called reverse Taylor rule with inflation gap own policy and evaluated it transparently. coefficient of 1.5 % and output gap coefficient As already said, Greenspan was replaced by Ber- of 1.0 %. This enables to extract the information nanke in his post. During this period the economic about the output growth. crisis has raised the issue of the most appropriate way to conduct the monetary policy and the number 3.3 Japan of critics has been increasing again. Application of the Taylor rule in this country was specific in comparison to other countries. The re- 3.2 Great Britain ason is low inflation even deflation, which is long- Although the Bank of England has not com- -term problem of the Japanese economy. If the mitted itself to follow strictly any monetary rule, key interest rates set by the central bank are close its main goal is to keep stable and low inflation. to zero, it is impossible to evaluate the moneta- Since June 1997, inflation target has been 2.5 % ry policy through the Taylor rule because it may [19]. Moreover, in the past years, central bank has result in negative values that cannot be applied.
Fig. 4: Comparison of the Taylor rule results and nominal interest rate in Great Britain from 1993 to 2001
Source: [19] E + M EKONOMIE A MANAGEMENT 3 / 2011 strana 21 EKONOMIE
Kuttner and Posen [12] worked out several economy reacted significantly to the changes in versions of both forward- and backward looking inflation rate, while the answers to movements of Taylor rules based on conditions of the Japanese output gap were negligible. economy in the years 1986–2001. They used the following form of the formula: 3.4 China i = (1 – – )[ r*+ * + (y – y* ) + ( – *)] + t U1 U2 S D t t E St S The authors of the Taylor rule in China are Xie + r + r (6) U1 t–1 U2 t–2 and Luo [12]. They analysed the situation from Except for the parameters and coefficients 1992 to 2001 and used the quarter data. Their included in the original formula, the interest rates formula has this form: from two previous periods were added here. In- it = (1-U)D+ (1-U)ESt + (1-U)Yyt + Uit-1+ Ht (7) flation was computed by CPI, the inflation target The coefficients are in the Tab. 3. is 1.0 %. The values of all the coefficients are co- Xie and Luo came to the conclusion that the llected in the Tab. 1 and Tab. 2 according to the forward-looking rule describes the Chinese eco- method used for calculating the output gap. nomic situation appropriately. According to the The Tab. 1 shows that the interest rate calcu- data, the output gap has larger influence on the lated by using the forward-looking rule was in interest rate than inflation. the analysed period sensitive mostly to the evo- lution of output gap. On the contrary, in case of forward-looking rule the coefficients of the output 3.5 The Czech Republic gap were relatively low. The high values were The Czech National Bank as the central bank only connected with E. Therefore, the Japanese and the monetary authority in the Czech Repub-
Tab. 1: Values of coefficients of the backward looking Taylor rule in Japan
Method of calculating output gap r* EDU1 U2 Linear trend 2.36 1.12 0.58 1.15 -0.29
HP filter 1.18 1.64 0.79 1.26 -0.36
Kuttner-Posen model 1.88 0.72 1.60 1.25 -0.34
Quadratic trend 0.87 0.60 0.57 1.38 -0.44 Source: [13]
Tab. 2: Values of coefficients of the forward-looking Taylor rule in Japan
Method of calculating output gap r* EDU1 U2 Linear trend 2.14 2.52 -0.04 1.31 -0.45
HP filter 2.34 2.46 -0.10 1.27 -0.42
Kuttner-Posen model 2.10 1.91 0.51 1.26 -0.37
Quadratic trend 1.95 1.93 0.01 1.49 -0.59 Source: [13]
Tab. 3: Coefficients of the Taylor rule in China DEJU 1.84 0.81 2.84 0.82 Source: [12] strana 22 3 / 2011 E + M EKONOMIE A MANAGEMENT EKONOMIE lic has used a new analytic tool, so called model takes into account unexpected shocks. Gradze- g3, since January 2007 [20]. This dynamic mo- wicz and Makarski suggested the following for- del provides the interpretation of actual econo- mula [8]: mic evolution of the country and consequently з = 0.71 з + 0.29 [1.31ʌո + 0.46Ǔ ] + 0.11d Ǔ + the prognosis of the future state including the t t-1 ո t t t analysis of the risks connected with this fore- + 0.2d ոʌtո ] + Mt (9) cast. The interest rate smoothing coefficient reaches Important part of this model is the forward-lo- the level of 0.71, which is under the expected oking reaction function of the central bank using value. On the contrary, inflation and GDP coeffi- the quarter data, which is based on the formula of cients are above the expectations. This Polish J. B. Taylor. It expresses the relationship between example has showed the importance of the mo- the nominal interest rate and the expected infla- netary rule that can help to specify the situation tion. In comparison to the original Taylor rule, it in the economy. excludes the output gap. Its form is [16]: Except for these countries, the Taylor rule is it = Uit - 4 + (1- U)(śt + \St+4) + Ht (8) also calculated in other countries, such as Hun- gary, Latin American countries or Australia. Our it represents nominal interest rate, U is the in- objective was to calculate the Taylor rule for Slo- terest rate smoothing parameter, śt stands for the neutral interest rate in the economy, which is the vakia. sum of real interest rate and inflation expectati- ons. \ presents the weight of the deviation of in- 4. Application of Monetary Rules in flation from its target and Ht expresses monetary policy shocks. Monetary Union This formula takes into account quarter data It would seem that it is not necessary to formu- and is forward-looking. late a particular monetary rule for each moneta- ry union member state separately, as monetary 3.6 Poland policy is applied in a common way for the whole Polish monetary reaction function combines union. However, if a National central bank knows the signs of models for closed economy and tho- a monetary rule for its country, it can defend eco- se for small open economy. The formula expre- nomic interests of that country in a more obvious sses the influence of inflation deviation from its and transparent way. It can give to the central target, GDP, interest rate growth rate and GDP bank more arguments in common decision ma- growth rate to the interest rate. Moreover, the rule king process.
Fig. 5: The Taylor rule based on actual and ex-post data in the euro area a) Production function approach b) HP-filter
Source: [1] E + M EKONOMIE A MANAGEMENT 3 / 2011 strana 23 EKONOMIE 4.1 The Euro Area rresponds to the one of the ECB, which is price stability. Inflation target is announced officially at Success of the Taylor rule inspired many ex- the level of 2 %. Slovak monetary policy is based perts to derive its form for the euro area. on inflation targeting. It can seem that a member Gerlach and Schnabel [7] have conducted re- state of the European Monetary Union does not search and found out that interest rate given by need an own monetary rule as a common moneta- Taylor was moving very closely to the interest ry policy is applied for the whole euro area. Loss rate in a real economy. Exceptions were only of independent monetary policy is one of the most years 1992, 1993, periods of disturbances on cited disadvantages of euro adoption. However, exchange market. a common monetary policy is often a compromi- Interesting results came out from a study by se taken during the Governing Council sessions Adema [1], as well. She criticized using ex-post where the Executive Board and the governors, data when calculating the Taylor rule. She pre- or presidents of all national central banks of the ferred actual data available in the period when euro area, meet usually twice a month. The Gover- monetary authority decides about the height of ning Council takes the monthly monetary policy interest rate. decisions, which means setting the key interest In order to compare the results based on va- rates for the euro area [8]. As governors of nati- rious data, she decided to analyse the situation onal central banks can intervene and vote, they both with ex-post and actual data. She estimated should know an optimal monetary rule for their interest rate to be 3 % and target inflation 2 %. country to influence e.g. level of base rates. An As the ECB uses HICP by calculating inflation, optimal monetary rule can facilitate their decision she used this index as well. Results are visible in making process, even if it is not a binding com- the Fig. 5. mitment. These two graphs show the difference between Several authors [18] have already tried to su- the results based on actual and ex-post data. It ggest an appropriate monetary rule for Slovak was not as clear as in the USA, as the relation conditions. Our objective was to calculate a sui- between the interest rates and the output gap is table form of such a rule applied to situation in weaker in Europe. It is well known also through Slovakia. The possible Taylor rule calculated eco- official statements of the FED´s and the ECB´s nometrically after Koyck transformation could be: goals.
BRt – U.BRt-1 = E0 + E1.HICPt + E2.PBt + ut 4.2 Slovakia U= 0.7944332 (10) Since January 2009, the Slovak Republic has The formula is based on quarter data from the been a member state of the euro area. Conse- second quarter 2000 till the end of 2008 gained quently, the goal of the Slovak central bank co- from the Eurostat and the National Bank of Slo- Tab. 4: Descriptive statisctics Key interest rate Inflation rate Balance of payments – Variable of NBS (BR) (HICP) annual change (PB) Number of observations 36 36 36
Mean 5.747 5.743 -0.444
Median 4.875 5.230 -0.027
Standard deviation 2.166 2.418 2.557
Variance 4.691 5.845 6.539
Minimum 2.500 2.719 11.468
Maximum 8.800 10.981 4.104 Source: own calculations according to [9] and [10] strana 24 3 / 2011 E + M EKONOMIE A MANAGEMENT EKONOMIE vakia (NBS) statistics [8], [9]. BR stands for key has taken inflation gap into account. Using inflati- interest rate set by the NBS. HICP represents on gap in the Slovak formula has led to the failure harmonised index of consumer process and is in residual normality test. Moreover, our derived smoothed by HP filter. The reason to apply HICP formula includes, beside inflation and output pa- as a measure of inflation was that it is used in rameters, the information about balance of pay- the whole euro area. PB is percentage change of ments as well. The main reason for the formula quarter imbalances of balance of payments. expansion is the fact that the Slovak economy is Descriptive statistics of the model is expressed significantly open, as it is obvious from several in Table 4. studies [23]. Both import and export ratios to This model fulfils tests of normality of residuals, GDP are above 70 % [14]. heteroscedasticity, multicolinearity and autoco- Moreover, the Taylor rule has been already mo- rrelation. dified in several countries and consequent the As we can see in Fig. 6, the differences be- Taylor-type rules were suggested (e.g. [8], [19]). tween the Slovak formula and the original Taylor Modifications of the Taylor rule were justified in rule are significant. First of all, this rule offers har- several publications, e.g. [18] with the respect to monised index of comsummer prices, while Taylor country specifics, level of a country centralisati-
Tab. 5: Results of modified Taylor equation Variables Estimated coefficients Standard error t value
Intercept -0.05473 0.22918 -0.239
HICP 0.18740 *** 0.03772 4.969
PB -0.06088 . 0.03311 -1.839
Signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1 Multiple R-squared: 0.4508 Adjusted R-squared: 0.4165 Source: own calculations according to [9] and [10]
Fig. 6: Evolution of key interest rate, output gap, inflation rate and imbalances changes in % since 2/2000 to 4/2008 10
5
0
2/2000 3/2000 4/2000 1/2001 2/2001 3/2001 4/2001 1/2002 2/2002 3/2002 4/2002 1/2003 2/2003 3/2003 4/2003 1/2004 2/2004 3/2004 4/2004 1/2005 2/2005 3/2005 4/2005 1/2006 2/2006 3/2006 4/2006 1/2007 2/2007 3/2007 4/2007 1/2008 2/2008 3/2008 4/2008 -5
Key interest rate of NBS in % -10 Output gap in % Inflation rate in % Change of imbalances of balance of payme -15 Source: own calculations according to [9] and [10] E + M EKONOMIE A MANAGEMENT 3 / 2011 strana 25 EKONOMIE on or decentralisation at regional level [27] and that Slovak central bank did not change its base particular macroeconomic circumstances. Con- rate abruptly but rather gradually. This fact is con- sequently, different variables can be taken into sistent with other studies, e.g. [18]. account in formulation of a Taylor type rule, e.g. Strong correlation (R2 = 0.978) between calcu- balance of payments, asset prices [24] etc. lated and really applied key interest rate indicates Consequently, the final output of our model is: succesfull the National Bank of Slovakia moneta- BR = -0.05473 + 0.7944332.BR + 0.18740. ry policy application and its coherence with the t t-1 Taylor-type rule. .HICPt – 0.06088.PBt (11) According to the formula, if HICP is raised 5. Conclusion by 1, the base interest rate should increase by 0.187. This coefficient confirms the reality. If the Many experts question nowadays, during the inflation is getting to higher values, it is usually world crisis, the accuracy of the Taylor-Type rules. connected with the growth that leads to overhea- They claim they bring negative results, which can- ting of the economy. Then the central bank could not be applied. Although Taylor himself states that raise the interest rates to slow the economy his original rule works even now and the FED does down and to prevent it from crossing the poten- not use the right data, positive opinion on this easy tial product. Close relationship between these formula is discredited. two variables is also observable on the Fig. 6. However, in the long term such a formula can be Both parameters have, in the analysed period, helpful. Central banks are able to decide about the a slightly decreasing trend. level of key interest rate more precisely. Naturally, The increase in changes in imbalances of ba- monetary rule should not be followed blindly; ne- lance of payments of 1 leads, as the formula says, vertheless, it should serve as a certain guideline. to the decrease in changes of key interest rate by After all, this has been the original message of the 0.061. However, if we express it absolutely, the Taylor rule. rise in imbalances of balance of payments should The Slovak Republic should not be an excepti- lead to a more significant increase in key interest on. The Taylor rule could represent a monetary tool rate. Apparently, this relationship is not as tight that helps to direct the requirements of the country as the previous ones, although it is still important. when deciding about the level of interest rates to This confirms the following graph, presenting be set in the euro area. Although, monetary deci- mostly contradictory trend of the variables. sions are valid in all member countries, they can Finally, comparatively high parameter associa- take part in discussions where the final consensus ted to key interest rate in previous period means, is achieved. Fig. 7: Evolution of balance of payments and key interest rate in % since 2/2000 to 4/2008 200,000 10
Balance of payments in mil. EUR 9 150,000 Key interest rate of NBS in % 8
7 100,000 6
50,000 5 4 0 3 6
04 07
001 004 007
2001 2001 2 2002 2 / /2003 /20 /2005 /2007 /2007 2/2000 3/2000 4/2000 1 2/ 3/2001 4/ 1/2002 2/2002 3/ 4/2002 1/2003 2/2003 3 4/2003 1/2 2/2004 3/2004 4 1/2005 2/2005 3 4/2005 1/2006 2/2006 3/200 4/2006 1 2 3/ 4/20 1/2008 2/2008 3/2008 4/2008 2 -50,000 1
-100,000 0 Source: own calculations according to [9] and [10] strana 26 3 / 2011 E + M EKONOMIE A MANAGEMENT EKONOMIE
Fig. 8: Comparison between the key interest rate in Slovakia and the estimated modified Taylor rule interest rate, observed period 2/2000–3/2009
Source: own calculations according to [9] and [10]
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strana 28 3 / 2011 E + M EKONOMIE A MANAGEMENT EKONOMIE ABSTRACT
MONETARY RULES AND THEIR APPLICATION IN TIMES OF ECONOMIC CRISIS AND IN THE EURO AREA
Marianna Siničáková, Viera Pavličková
The Taylor-type rules and similar monetary rules gained much sympathy during previous periods because of their simplicity and transparency. However, the period of crisis threatened their posi- tion in the application of monetary policy. It seemed that the Taylor rules were not valid any more. Despite this fact, Taylor managed to defend his rule for the moment arguing that the data used by the Federal Reserve System were not correct. The Taylor-type rules were discredited. Still, in long- -term their application can be important. In the paper we have compared the formulations of monetary rules in several countries. Moreo- ver, it would seem that the application of monetary rules makes no sense for the individual euro area member states, as their monetary policy is applied in a common way by the European Central Bank. Though, if a national central bank knows a monetary rule for its country, it can defend eco- nomic interests of that country in a more obvious and transparent way. It can give to the central bank more arguments in common decision making process at the level of the European Central Bank Governing Council. Consequently, we have decided to calculate a monetary rule for Slovakia as the latest euro area member state. Our derived formula includes, besides harmonised index of consumer prices, lagged base rates, the data on balance of payments as well. The main reason for the formula expansion is the fact that the Slovak economy is significantly open. Besides these facts, other aspects had to be taken into consideration, too. Naturally, any monetary rule should not be followed blindly; nevertheless, it should serve as a certain guideline. After all, this has been the original message of the Taylor rule.
The paper was elaborated within the project VEGA 1/0973/11.
Key words: monetary policy rules, the Taylor rule, discretion, the euro area, economic crisis.
JEL Classification: E52, E 58.
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