Central Bank Reaction Functions in Inflation and Non-Inflation Targeting Countries: Are They Informative About the Conduct of Monetary Policy?

Abstract

This paper seeks, through the estimation of central bank reaction functions for 19 OECD countries in a panel setting, to examine the relationship between certain key target variables and an instrument of monetary policy, namely short-term interest rates. A rolling, reduced form, vector autoregression of interest rates, unemployment and inflation rates is employed to mimic a central bank's information set. The results of this study suggest that central banks react in a predictable manner to unemployment and inflation innovations. However, when the group of inflation targeting countries are separately considered, reaction functions are much more informative about both central bank and government motives.