Monetary Policy Autonomy: Identification and Cross-Country Evidence

Abstract

This paper revisits the definition of monetary policy autonomy and develops a new method to identify autonomy regimes for a set of countries. Compared to the traditional identification approach, which only focuses on correlations among domestic and foreign interest rates, monetary policy autonomy in this paper is jointly determined by how the domestic interest rate responds to domestic inflation and real GDP in addition to its sensitivity to foreign interest rates. Furthermore, such an identification approach does not rely on the exchange rate regime or capital control indices. Using a Markov Switching model for the monetary policy function, I estimate policy responses in two regimes, and obtain measures of monetary policy autonomy in the process. Applying the method to the data from a set of advanced countries, I find monetary policy autonomy decreases when the exchange rate is fixed or capital controls are loosened. These results are consistent with the open economy trilemma.