Inflationary effect of oil price and non-oil price on monetary policy reaction: Symmetric versus asymmetric cointegration modelling

Abstract

It is well-documented in previous literature that a monetary policy reaction function reacts to inflation and output gap. This rule is termed as Taylor rule. In this study, we extend the study on monetary policy reaction by investigating the inflationary effect from oil price and non-oil price on triggering the reaction of monetary policy function. We focus the study in Thailand, a country that has experienced drastic switch in monetary policy regime from rigid exchange rate to floating exchange rate coexist with inflation targeting regime after the financial crisis of 1997. The study applies symmetric and asymmetric cointegration and error correction models to capture the symmetric/ asymmetric adjustment in policy reaction function if any. In particular, we seek to reveal if the policy function shows asymmetric adjustment towards inflationary effect and how influential the effect from oil price and non-oil price on stimulating policy rate adjustment. The results are compared between the two different policy regime periods. The results detect symmetric adjustment in monetary policy reaction function. However, oil price does not induce monetary policy reaction in the long run. Monetary policy reaction is more reactive and sensitive to inflation, output and exchange rate (non-oil price factors). The pre-inflation targeting regime was associated with higher policy rate (more tightening policy) compared to the post-inflation targeting regime.