Monetary policy rules and inflation process in open emerging economies: evidence for 12 new EU members

This paper has three objectives. First, it aims at revealing the logic of interest rate setting pursued by monetary authorities of 12 new EU members. Using estimation of an augmented Taylor rule, we find that this setting was not always consistent with the official monetary policy. Second, we seek to shed light on the inflation process of these countries. To this end, we carry out an estimation of an open economy Philips curve (PC). Our main finding is that inflation rates were not only driven by backward persistency but also held a forward-looking component. Finally, we assess the viability of existing monetary arrangements for price stability. The analysis of the conditional inflation variance obtained from GARCH estimation of PC is used for this purpose. We conclude that inflation targeting is preferable to an exchange rate peg because it allowed decreasing the inflation rate and anchored its volatility.http://deepblue.lib.umich.edu/bitstream/2027.42/64365/1/wp968.pd

Inflation dynamics and the New Keynesian Phillips curve in EU-4

The paper seeks to shed light on inflation dynamics of four new EU member states (the Czech Republic, Hungary, Poland and Slovakia). To this end, the New Keynesian Phillips curve augmented for open economies is estimated and additional statistical tests applied. We find the following. (1) The claim of New Keynesians that the real marginal cost is the main inflation-forcing variable is fragile. (2) Inflation seems to be driven by external factors. (3) Although inflation holds forward-looking component, the backward-looking one is substantial. An intuitive explanation for higher inflation persistence may be rather adaptive than rational price setting of local firms.Inflation dynamics, New Keynesian Phillips curve, CEE countries, GMM estimation

Is Monetary Policy in New Members States Asymmetric?

Estimated Taylor rules became popular as a description of monetary policy conduct. There are numerous reasons why real monetary policy can be asymmetric and estimated Taylor rule nonlinear. This paper tests whether monetary policy can be described as asymmetric in three new European Union (EU) members (the Czech Republic, Hungary and Poland), which apply an inflation targeting regime. Two different empirical frameworks are used: (i) a Generalized Method of Moments (GMM) estimation of models that allow discrimination between the sources of potential policy asymmetry but are conditioned by specific underlying relations (Dolado et al., 2004, 2005; Surico, 2007a,b); and (ii) a flexible framework of sample splitting where nonlinearity enters via a threshold variable and monetary policy is allowed to switch between regimes (Hansen, 2000; Caner and Hansen, 2004). We find generally little evidence for asymmetric policy driven by nonlinearities in economic systems, some evidence for asymmetric preferences and some interesting evidence on policy switches driven by the intensity of financial distress in the economy.monetary policy, inflation targeting, nonlinear Taylor rules, threshold estimation

Monetary policy rules and inflation process in open emerging economies: evidence for 12 new EU members

This paper has three objectives. First, it aims at revealing the logic of interest rate setting pursued by monetary authorities of 12 new EU members. Using estimation of an augmented Taylor rule, we find that this setting was not always consistent with the official monetary policy. Second, we seek to shed light on the inflation process of these countries. To this end, we carry out an estimation of an open economy Philips curve (PC). Our main finding is that inflation rates were not only driven by backward persistency but also held a forward-looking component. Finally, we assess the viability of existing monetary arrangements for price stability. The analysis of the conditional inflation variance obtained from GARCH estimation of PC is used for this purpose. We conclude that inflation targeting is preferable to an exchange rate peg because it allowed decreasing the inflation rate and anchored its volatility.open emerging economies, CEE countries, monetary policy rules, open economy Phillips curve, conditional inflation variance

Is Monetary Policy in New Members States Asymmetric?

Estimated Taylor rules became popular as a description of monetary policy conduct. There are numerous reasons why real monetary policy can be asymmetric and estimated Taylor rule nonlinear. This paper tests whether monetary policy can be described as asymmetric in three new European Union (EU) members (the Czech Republic, Hungary and Poland), which apply an inflation targeting regime. Two different empirical frameworks are used: (i) a Generalized Method of Moments (GMM) estimation of models that allow discrimination between the sources of potential policy asymmetry but are conditioned by specific underlying relations (Dolado et al., 2004, 2005; Surico, 2007a,b); and (ii) a flexible framework of sample splitting where nonlinearity enters via a threshold variable and monetary policy is allowed to switch between regimes (Hansen, 2000; Caner and Hansen, 2004). We find generally little evidence for asymmetric policy driven by nonlinearities in economic systems, some evidence for asymmetric preferences and some interesting evidence on policy switches driven by the intensity of financial distress in the economy.http://deepblue.lib.umich.edu/bitstream/2027.42/133019/1/wp1005.pd

How Does Monetary Policy Change? Evidence on Inflation Targeting Countries

We examine the evolution of monetary policy rules in a group of inflation targeting countries (Australia, Canada, New Zealand, Sweden and the United Kingdom) applying moment-based estimator at time-varying parameter model with endogenous regressors. Using this novel flexible framework, our main findings are threefold. First, monetary policy rules change gradually pointing to the importance of applying time-varying estimation framework. Second, the interest rate smoothing parameter is much lower that what previous time-invariant estimates of policy rules typically report. External factors matter for all countries, albeit the importance of exchange rate diminishes after the adoption of inflation targeting. Third, the response of interest rates on inflation is particularly strong during the periods, when central bankers want to break the record of high inflation such as in the U.K. or in Australia at the beginning of 1980s. Contrary to common wisdom, the response becomes less aggressive after the adoption of inflation targeting suggesting the positive effect of this regime on anchoring inflation expectations. This result is supported by our finding that inflation persistence as well as policy neutral rate typically decreased after the adoption of inflation targeting.Endogenous regressors, inflation targeting, monetary policy, Taylor rule, time-varying parameter model.

How systemic is Spain for Europe?

We use the forecast-error variance decompositions from a VAR with daily sovereign bonds spreads since 2000 to detail the linkages between EU sovereign bond markets and banks over time. Using new summary statistics on the matrix of bilateral linkages, we show Spain is systemic for Europe. Its fiscal problems expose it to trouble in sovereign bond markets of the other Club Med countries, whereas its internationally grown banking sector transmits domestic economic trouble to the rest of Europe. This spillover has substantially increased since the outbreak of the Fiscal Crisis in the Eurozone in May 2010. We develop a real-time indicator to follow the degree of spillover on a daily basi

Measuring Sovereign Bond Spillover in Europe and the Impact of Rating News

Although there is by now strong evidence that sovereign risk premia are driven by a common factor, little is known about the detailed linkages between sovereign bond markets. We employ the VAR method by Diebold and Yilmaz, 2009, to analyse the strength and direction of bilateral linkages between EU sovereign bond markets using daily data on sovereign bond yield spreads and a common factor. The forecast-error variance decomposition of this FAVAR indicates a lot of heterogeneity in the bilateral spillover sent and received between bond markets. Spillover is more important than domestic factors for all eurozone countries. The CE countries mostly affect each other. Only Denmark, Sweden and the UK are rather insulated from spillover. The spillover has increased substantially since 2007, despite starting from a high level. We use this framework to measure the impact of sovereign rating news and analyse the dynamic linkages between spreads and the ratings of the main credit rating agencies. We find a two-sided relation between rating news and sovereign risk premia. The spillover of rating news is very heterogeneous, and it is substantially stronger for downgrades at lower grades. The impact is often weaker domestically than on bond spreads of other sovereigns

Inflation dynamics and the New Keynesian Phillips curve in EU-4

The paper seeks to shed light on inflation dynamics of four new EU member states: the Czech Republic, Hungary, Poland and Slovakia. To this end, the New Keynesian Phillips curve augmented for open economies is estimated and additional statistical tests applied. We find the following. (1) The claim of New Keynesians that the real marginal cost is the main inflation-forcing variable is fragile. (2) Inflation seems to be driven by external factors. (3) Although inflation holds a forward-looking component, the backward-looking component is substantial. An intuitive explanation for higher inflation persistence may be rather adaptive than rational price setting of local firms

The Monetary policy rules and the inflation process in open emerging economies : evidence for 12 new EU members

This paper has three objectives. First, it aims at revealing the logic of interest rate setting pursued by monetary authorities of 12 new EU members. Using estimation of an augmented Taylor rule, we find that this setting was not always consistent with the official monetary policy. Second, we seek to shed light on the inflation process of these countries. To this end, we carry out an estimation of an open economy Philips curve (PC). Our main finding is that inflation rates were not only driven by backward persistency but also held a forward-looking component. Finally, we assess the viability of existing monetary arrangements for price stability. The analysis of the conditional inflation variance obtained from GARCH estimation of PC is used for this purpose. We conclude that inflation targeting is preferable to an exchange rate peg because it allowed decreasing the inflation rate and anchored its volatility