In emerging economies, implementation of monetary policy does not always seem to be in line with the officially announced monetary policy strategy. There may be simple reasons for this: the central bank may have limited independence with respect to monetary policy, there may be a limited number of instruments available or the money markets may be underdeveloped. We can, however, use empirical research to identify central banks’ implicit responses to developments in the economy. Many emerging markets have substantially improved their institutions since the crises of the 1990s. This makes it interesting to examine whether the rules employed in analysing developed economies’ monetary policies can also be applied to analysing the monetary policies pursued in emerging economies.
Currently, a BOFIT study on monetary policy behaviour in emerging economies is being carried out by Aaron Mehrotra (BOFIT) and José R. Sánchez-Fung (Kingston University, London). They are working on estimates of monetary policy rules for twenty countries with a broad and varied geographical spread, encompassing economies in Europe, Latin America, Asia and Africa. The monetary policy strategies reported by these countries have also varied. The majority have adopted a strategy based on an inflation target, but some have set targets for the money supply or the exchange rate. The study presents in detail the countries’ monetary policy institutions (including operative instruments and inflation targets) and uses these details to select the monetary policy rules to be estimated.
In addition to the traditional Taylor rule, the study also estimates McCallum’s monetary-policy rule as well as variants of these two reaction functions. In the Taylor rule, nominal interest rates respond to inflation and output gaps. In the McCallum rule, the central bank uses the monetary base as an instrument that it regulates according to changes in the nominal income gap. The study also examines the applicability of the nominal feedback rule to emerging markets. Real-economy variables are not needed in estimating a nominal feedback rule that includes an implicit central bank inflation target. This may be an advantage in economies where real-economy statistics are only available after a long time lag or where the quality of statistics is poor. All the rules analysed in the study also allow for the central bank’s response to changes in the exchange rate, which may be particularly important considering the economies are primarily small, open economies.
The results of the study show that a hybrid McCallum-Taylor rule, where the interest rate instrument reacts to the nominal income gap, is better suited to describing the monetary policy of countries using an inflation target than the benchmark Taylor rule. In countries where a McCallum monetary policy rule is used, monetary policy is sometimes found to lean against the wind, ie monetary policy is stabilising. However, the outcome of McCallum-type rules depends on the way in which the nominal income gap is defined. Instrument smoothing is important for both Taylor and McCallum rules, ie lagged values of the policy instrument are significant determinants of the level of the instrument in the current period. For countries where the nominal feedback rule is estimated, the results primarily imply monetary policy behaviour that is leaning with the wind, where policy adapts to changes in actual inflation. The results are robust irrespective of different estimation methods.
References:
Dueker, Michael, and Andreas M. Fischer (1998) A guide to nominal feedback rules and their use for monetary policy, Federal Reserve Bank of St. Louis Review, 80, July-August, 55–63.
McCallum, Bennett T. (1988) Robustness properties of a rule for monetary policy,
Carnegie-Rochester Conference Series on Public Policy, 29, 53–84.
Taylor, John B. (1993) Discretion versus policy rules in practice, Carnegie Rochester
Conference Series on Public Policy, 39, 195–214. |