how does monetary policy change? evidence on inflation targeting countries
DESCRIPTION
How Does Monetary Policy Change? Evidence on Inflation Targeting Countries. Jaromír Baxa , Charles University, Prague Roman Horváth , Czech National Bank Bořek Vašíček , University of Barcelona The 7th Norges Bank Monetary Policy Conference , 2 4 June 20 10 - PowerPoint PPT PresentationTRANSCRIPT
How Does Monetary Policy Change?
Evidence on Inflation Targeting Countries
Jaromír Baxa, Charles University, PragueRoman Horváth, Czech National Bank Bořek Vašíček, University of Barcelona
The 7th Norges Bank Monetary Policy Conference, 24 June 2010
The views expressed here do not necessarily represent those of the CNB.
2
Road Map
• Motivation• Related Literature• Data and Empirical Methodology• Empirical Results• Concluding Remarks
3
Motivation
• How and when does monetary policy change?• Does inflation targeting represent a major change in
monetary policy?• When do central bankers respond more aggressively on
inflation?• To what degree the policy is smoothed?• How persistent is inflation process?• How important is financial stress for interest rate setting?
4
Related Literature –Monetary policy rules and inflation targeting
• Most studies available for the Bank of England (1992): Clarida et al.(1998, 2000), Adam et al. (2005), Davradakis and Taylor (2006), Assenmacher-Wesche (2006), Trecroci and Vassalli (2009)
• Reserve Bank of New Zealand (1990): Huang et al. (2001),Karedekikli and Lees (2007), Ftiti (2008)
• Reserve Bank of Australia (1993): Bouwer and Gilbert (2005), Leu and Sheen (2006)
• Bank of Canada (1991): Demers and Rodríguez (2002), Shih and Giles (2009)
• Sveriges Riksbank (1993): Jansson and Vredin (2003), Kuttner (2004), Berg et al. (2004)
5
Related Literature – Time variance in monetary policy rules (1)
• Sub-sample analysis with forward-looking policy rules (Clarida et al., 1998, 2000)
• Endogenous regressors addressed by GMM • Strong assumption that monetary policy is subject to
structural breaks when the FED chairman changes• Structural stability within sub-sample assumed
6
Related Literature – Time variance in monetary policy rules (2)
• The Markov-switching VARs with time variance in coefficients and residual variances (Assenmacher-Wesche, 2006,
Sims and Zha, 2006) • Time variance in coefficients and residual variances to deal
with changing monetary policy and economic stability• Monetary policy forced to exhibit sudden switches from one
policy regime to another one• Forward-looking element in monetary policy not explicitly
addressed
7
Related Literature – Time variance in monetary policy rules (3)
• The Kalman filter to estimate time-varying coefficient model (Boivin, 2006,Trecrocci and Vasalli, 2010, Gorodichenko and Coibion, 2010)
• Time variance in coefficients and residual variances to deal with changing monetary policy and economic stability
• Endogenous regressors typically not addressed (Kim and Nelson, 2006)
• Endogeneity even in forward-looking rules with real-time forecasts, if forecasts not derived under assumption of constant nominal interest rates within the forecasting horizon
8
Our econometric framework
• Time-varying coefficient model with endogenous regressors
• The policy may change gradually as well as abruptly• Heckman-type two stage procedure that corrects
endogeneity in time-varying model (Kim, 2006)• Small sample issues: Moment-based estimator that has
slightly better statistical properties in small samples than traditional Kalman filtering (Schlicht and Ludsteck, 2006)
9
Empirical methodology
• Monetary policy rule
• Time-varying coefficients follow random walk
• Endogenous regressors and instruments (Z)
11t t t t t i t t t t t t tr y x r
,
,
1 1t t t , 1
2~ . . . 0,t i i d N
1 2t t t , 2
2~ . . . 0,t i i d N
1 3t t t , 3
2~ . . . 0,t i i d N
1 4t t t , 4
2~ . . . 0,t i i d N
1 5t t t , 5
2~ . . . 0,t i i d N
't i t j tZ , ~ . . . 0,1t i i d N
't t j ty Z , ~ . . . 0,1t i i d N
10
Empirical methodology (cont.)
• Estimates of the coefficients in the monetary policy rule are obtained in two steps
1. Endogenous regressors regressed on the instruments and standardized residuals and saved
2. Standardized residuals included as endogeneity bias correction terms in monetary policy rule
t t
11t t t t t i t t t t t t ν,ε ε,t t ,ε ε,t t tr π y x r κ σ ν κ σ
2 2 2, , ,~ 0, (1 )t v tN
11
Varying Coefficients
• “Varying coefficients” method (Schlicht and Ludsteck, 2006) for estimation
• Minimal assumptions on the variance of error terms• Generalization of OLS, minimizes the weighted sum
• Weights inverse variance ratios of the regression residuals and the shocks in time-varying coefficients balancing the fit of the model and the parameter stability
2 2 2 21 1 2 2 n n
1 1 1 1
T T T T
t= t= t= t=
+θ +θ + θ
12
Data
• Quarterly data• UK 1975:1Q -2007:4Q, Australia 1972:4Q - 2007:4Q, Canada 1975:1Q -
2007:4Q, New Zealand 1985:1Q - 2008:2Q, Sweden 1982:2Q - 2007:3Q• The dependent variable is the short-term interest rate closely linked
to monetary policy• The inflation rate is measured as year-on-year change of CPI (RPIX
for the UK and CPIX for NZ)• The output gap is from OECD: production function method based on
NAWRU (HP filter for NZ)• The nominal effective exchange rate (USD/CAD for CAN) used in its
deviation from HP trend• Foreign interest rate – German rate for EU countries, US for the rest
13
Results - Sweden
• Policy neutral rate falling from some 5% in 1980s to 3% in 2000s
• Response to inflation strong, but somewhat less aggressive under IT (anchored expectations)
• No response to output gap• IR smoothing somewhat
higher than in other countries
• 95% confidence interval
Policy neutral rate Response to expected inflation
Response to output gap Interest rate smoothing
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
82 84 86 88 90 92 94 96 98 00 02 04 06
RHO RHO_LB RHO_UB
-0 .8
-0 .4
0 .0
0 .4
0 .8
1 .2
1 9 8 5 1 9 9 0 1 9 9 5 2 0 0 0 2 0 0 5
UBGA MMA LB GAM MA G AMM A
-1
0
1
2
3
4
1 9 8 5 1 9 9 0 1 9 9 5 2 0 0 0 2 0 0 5
BE TA L BB ETA UBB ET A
0
2
4
6
8
1 0
1 2
1 9 8 5 1 9 9 0 1 9 9 5 2 0 0 0 2 0 0 5
AL PHA UB ALP HA L BA LPHA
14
Results – Monetary Policy Aggressiveness and Inflation Targeting
• Monetary policy less aggressive after IT adoption, if previous inflation record favorable
• Anchored inflation expectations under IT do not necessitate aggressive policy
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
0.7
0.8
0.9
1.0
1.1
1.2
1.3
AUS CAN NZUK SWE
IT Adoption
15
Results - Monetary Policy
Aggressiveness and Inflation Rate
• The response on inflation particularly strong during the periods, when central bankers want to break the record of high inflation
United Kingdom
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
0 4 8 12 16 20 24
Inflation
Aggre
ssiveness
New Zealand
0.7
0.8
0.9
1.0
1.1
1.2
1.3
-1 0 1 2 3 4 5 6 7 8
Inflation
Aggre
ssiveness
Australia
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
-2 0 2 4 6 8 10 12 14
Inflation
Aggre
ssiveness
Canada
0.6
0.7
0.8
0.9
1.0
1.1
1.2
1.3
-2 0 2 4 6 8 10 12 14
Inflation
Aggre
ssiveness
Sweden
0.0
0.4
0.8
1.2
1.6
2.0
2.4
0 2 4 6 8 10 12
Inflation
Aggre
ssiveness
16
Results – Interest Rate Smoothing
• Time-varying estimates of interest rate smoothing are well below the time-invariant one of Clarida et al.
• Is omission of time-varying nature of policy another reason for the overestimation of smoothing coefficient?
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
AUS CAN Clarida et al.NZ SWE UK
17
Results - Inflation Targeting and Inflation Persistence
• Inflation less persistent after IT adoption
• Persistence measured as the coefficient on lagged inflation in backward-looking Phillips curve with time-varying coefficients
-0.8
-0.4
0.0
0.4
0.8
1.2
UK SWE AUSCAN NZ
IT Adoption
18
Follow-up paper
Time-Varying Monetary Policy Rules and Financial Stress
To what extent is financial stress important in interest rate setting?
To what extent financial stress mattered for conventional monetary policies during 2008-2009 crisis?
19
• Time-varying monetary policy rule estimation for main IT countries and US
• IMF’s Financial stress indicator (and its subcomponents) added as additional explanatory variable
• Do central banks respond to financial stress? • Which periods and type of stress are for central banks the
most worrying?
20
Results - The Effect of Financial Stress on Interest Rate Setting
• Central bank loosen policy in the face of high financial stress
• Financial stress explain 10-50% of interest rate variations during 2008-2009 crisis (50% for the U.K)
USA
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
1981
1983
1984
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
UK
-2.5
-2
-1.5
-1
-0.5
0
0.5
1981
1983
1984
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Sweden
-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1981
1983
1986
1989
1992
1995
1998
2001
2004
2007
Canada
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
0.4
0.5
0.6
1981
1983
1986
1989
1992
1995
1998
2001
2004
2007
21
The Effect of Financial Stress Components on Interest Rate Setting:Bank, Exchange Rate and Stock Market Stress
• Exchange rate stress of more concern in more open economies
• Bank stress and stock market stress dominant
USA
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
1981
1983
1984
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Bank stress Stock market stress Exchange rate stress
UK
-2
-1.5
-1
-0.5
0
0.5
1981
1983
1984
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Bank stress Stock market stress Exchange rate stress Sweden
-2
-1.5
-1
-0.5
0
0.5
1981
1983
1986
1989
1992
1995
1998
2001
2004
2007
Bank stress Stock market stress Exchange rate stress
Canada
-1.5
-1
-0.5
0
0.5
1
1981
1983
1986
1989
1992
1995
1998
2001
2004
2007
Bank stress Stock market stress Exchange rate stress
22
Concluding Remarks
• The evolution of monetary policy in main IT central banks over the last three decades examined
• Policy changes gradually rather than abruptly• The response on inflation more aggressive during the periods when
central bankers want to break the record of high inflation • The response on inflation less aggressive after IT adoption• Central banks loosen monetary policy in the face of high financial
stress
Thank you for your attentionDěkuji Vám za pozornost (in Czech)
www.cnb.cz
Contacts:Roman Horváth
Czech National [email protected]
http://works.bepress.com/roman_horvath/