Estimating the immediate impact of monetary policy shocks on the exchange rate and other asset prices in Hungary

The paper estimates the immediate impact of Hungarian monetary policy on three classes of asset prices: the exchange rate of the forint vis-à-vis the euro, spot and forward government bond yields and the index of the Budapest Stock Exchange. The endogeneity problem is treated with the method of identification through heteroskedasticity as described by Rigobon and Sack (2004). The results suggest a significant impact on the exchange rate in one day i.e. an increase in the policy rate leads to an appreciation of the domestic currency, which is in line with the classic intuition. The effect increases markedly when the estimation is carried out with a two-day window suggesting the inefficiency of markets in incorporating monetary policy decisions in asset prices in a short period of time. Monetary policy affects spot yields positively, but the effect gradually dies out as the horizon gets longer. This can be explained with the impact on forward yields, as the results suggest a positive impact on short-term and a negative impact on long-term forward yields meaning that a surprise change in the policy rate leads to a rotation of the forward curve. The method does not provide interpretable and significant results for the stock exchange index.Monetary transmission mechanism, Asset prices, Exchange rate, Yield curve, Stock market, Identification, Heteroskedasticity.

Analysing currency risk premia in the Czech Republic, Hungary, Poland and Slovakia

The paper estimates currency risk premia for the Czech Republic, Hungary, Poland and Slovakia. Three different approaches are applied: a constant premium approach based on rational expectations, while time-varying premia are estimated with a method using financial market analysts’ surveys and also with a Kalman filter technique. A novelty in this paper is a crosscheck based on the three different approaches applied and also making use of implied and historical volatilities. The results highlight the importance of such a crosscheck: in the case of the Czech and the Slovak koruna and the Polish zloty this exercise reveals severe problems with the results, which otherwise would not have been discovered. On the other hand, the estimation methods produce convincing results for the Hungarian forint. The estimated Hungarian premium series reflect the major events that intuitively may have shaped currency risk in the country. A possible reason for these findings is a high signal-to-noise ratio in the case of Hungary where the risk premium has been large and exhibited substantial shifts through time. Finally, the strong comovement of the premium series obtained with the Kalman-filter and the survey data for the Hungarian forint also indicates that the survey expectations are largely in line with both the riskpremium- extended UIP and the rational expectations hypothesis, which is theoretically important as the UIP relates exchange rate expectations to the interest rate differential.risk premium, exchange rate, Kalman filter, survey data

The theory and practice of interest rate smoothing

The interest rate policy of the Magyar Nemzeti Bank typically consists of taking several smaller steps in one direction. Other central banks follow similar practices. Their interest rate policy actions are characterised by gradual changes: in other words, they avoid sudden, major changes in interest rates and are wary of reversing interest rate cycles too frequently. This study will present the theoretical background of the practice of such interest rate smoothing, the motivations of central banks as revealed by their communication, and some important considerations for Hungarian monetary policy.interest rate smoothing, base rate, monetary policy.

Hungary's eurozone entry date: What do the markets think and what if they change their minds?

This article investigates the potential impact of a shift in market expectations about a country's eurozone entry date on long-term yields and the spot exchange rate in a simple uncovered interest parity (UIP) framework. The results suggest that the size of the reactions depend on how far the entry date is postponed, how far current inflation is from the Maastricht-satisfying level, and whether the credibility of the central bank's target inflation path is sensitive to changes in the expected entry date. In the empirical part, the authors apply the framework for Hungary and draw some policy conclusions for the timing of ERM II entry

Estimating the immediate impact of monetary policy shocks on the exchange rate and other asset prices in Hungary

The paper estimates the immediate impact of Hungarian monetary policy on three classes of asset prices: the exchange rate of the forint vis-r-vis the euro, spot and forward government bond yields and the index of the Budapest Stock Exchange. The endogeneity problem is treated with the method of identification through heteroskedasticity as described by Rigobon and Sack (2004). The results suggest a significant impact on the exchange rate in one day i.e. an increase in the policy rate leads to an appreciation of the domestic currency, which is in line with the classic intuition. The effect increases markedly when the estimation is carried out with a two-day window suggesting the inefficiency of markets in incorporating monetary policy decisions in asset prices in a short period of time. Monetary policy affects spot yields positively, but the effect gradually dies out as the horizon gets longer. This can be explained with the impact on forward yields, as the results suggest a positive impact on short-term and a negative impact on long-term forward yields meaning that a surprise change in the policy rate leads to a rotation of the forward curve. The method does not provide interpretable and significant results for the stock exchange index

Monetary Transmission in Hungary

The Hungarian Monetary Transmission Mechanism research project was expected to fill the gaps in our knowledge. Almost fifteen years after the beginning of the Hungarian transition to a market economy, we felt that the time has come to launch a comprehensive research project with the purpose of obtaining an understanding based on more solid econometric results. Our project was also motivated by the Monetary Transmission Network in the Eurosystem, which gave us the opportunity to compare the Hungarian transmission mechanism to that of the euro area. It took almost three years for the colleagues at the Bank's economics department to explore the most important areas of the transmission mechanism. The research faced several challenges. The data used for estimation are still not completely satisfactory. Moreover, the framework of monetary policy, as well as some structural features of the Hungarian economy have changed during the period under investigation. Moreover, the special characteristics of our economy required a focus somewhat different from what is usual in the literature. Due to the uneven information available regarding the various sectors and markets, it was clear from the beginning that some areas would have to receive only limited coverage, rendering the synthesis of individual results difficult. Despite these shortcomings, the empirical work presented in this volume allows us to gain a better understanding of the Hungarian monetary transmission mechanism and has thus served its stated objective well. The benefits of the project are threefold. First, it confirms our assumption about the primacy of the exchange rate channel in Hungary's small open economy. Second, there are some interesting results that may alter our thinking about how the monetary transmission works. For example, we obtained a refined and – at least compared to earlier beliefs – slightly different picture about the way consumption and investments react to monetary policy actions . Third, it brought to the fore important areas where our knowledge is far from being satisfactory. This recognition calls for further research in order to strengthen the theoretical underpinnings of our monetary policy actions. Such areas are, for example, the labour market and credit markets. We also need a deeper understanding of the factors at work determining the exchange rate. This volume collects the papers written by the project participants. The volume is structured as follows. Studies dealing with the first stages of the transmission mechanism, i.e. how the monetary policy actions are transmitted to financial markets and asset prices, are presented first. They are followed by papers estimating the macroeconomic effects of monetary policy and the behavior of aggregate demand. The last study in the volume tries to assess the potential consequences on the transmission mechanism of joining the eurozone.monetary transmission, Hungary, interest rate pass-through, monetary policy shock, exchange rate smoothing, bank-lending, structural VAR, aggregate demand, investment behavior, euro.

HUNGARY'S EUROZONE ENTRY DATE: WHAT DO THE MARKETS THINK AND WHAT IF THEY CHANGE THEIR MINDS?

This article investigates the potential impact of a shift in market expectations about a country's eurozone entry date on long-term yields and the spot exchange rate in a simple uncovered interest parity (UIP) framework. The results suggest that the size of the reactions depend on how far the entry date is postponed, how far current inflation is from the Maastricht-satisfying level, and whether the credibility of the central bank's target inflation path is sensitive to changes in the expected entry date. In the empirical part, the authors apply the framework for Hungary and draw some policy conclusions for the timing of ERM II entry. (JEL "E44", "E52", "F33") Copyright 2006 Western Economic Association International.