IS THE TUNISIAN CENTRAL BANK FOLLOWING A LINEAR OR A NONLINEAR AUGMENTED TAYLOR RULE?

Beldi Lamia,Mouldi Djelassi

doi:10.32479/ijefi.8975

Abstract

The political transition in the Arab Spring countries has been accompanied by a deterioration of economic and financial indicators like in the Tunisian case. This paper aims to get a deeper understanding of the nature of the rule that reflects the behavior of the Tunisian monetary authority in the current dominance of economic and financial instability. In particular, this paper assesses whether the Tunisian Central Bank is indeed following a linear or a non linear augmented Taylor rule. For our purpose, we use a forward looking version of Taylor rule augmented by including the effect of exchange rate to estimate the linear and the nonlinear models. A smooth transition regression model is used to estimate the nonlinear rule. The results obtained imply that the Tunisian Central Bank follows a nonlinear Taylor rule in the conduct of monetary policy. In addition, our evidence suggests that the reaction of monetary authority in Tunisia to the deviation of forecasts of inflation rate, output gap and exchange rate changes in terms of magnitude and statistical significance across the high and low interest rate regimes. In particular, when the lagged interest rate is above the threshold level of 4.76%, the main objective of the policy makers is to fight the inflation rate and to limit the depreciation of exchange rate rather than to boost the economic activity.Keywords: Taylor rule, smooth transition regression model, interest rate reaction function, nonlinearityJEL Classifications: C22, E17, E43, E52, E58DOI: https://doi.org/10.32479/ijefi.8975

Highlights

Assessing the behavior of monetary authority in response to economic fundamentals is the subject of an intense debate among policymakers
Results of the Nonlinear Taylor Rule According to the results of Table 4 of linearity test, it’s clear that BCT follows a nonlinear Taylor rule, the rejection of the linear model. This implies that the inflation rate, output gap, exchange rate and the lagged interest rate are related to the nonlinear behavior of the BCT
When the lagged of interest rate is above the threshold level of 4.76%, the BCT makes a change in its interest rate decision from a low interest rate regime to a high interest rate regime

Summary

Introduction

Assessing the behavior of monetary authority in response to economic fundamentals is the subject of an intense debate among policymakers. The popular reaction function proposed by Taylor (1993), establishes a linear link between the central bank interest rate, inflation and the output gap. It describes how the policy interest rate reacts to the deviation of inflation from its target and to the deviation of output from its potential: it r* St T St S * t E y yt (1). In the standard form of Taylor rule, the central banks use past or current values of inflation and output gap to set up the interest rate.

Objectives

Methods

Results

Conclusion