Nonlinearities in Central Bank of Tunisia’s Reaction Function: Pre-and Post Revolution Analysis

Abstract

This paper seeks to check the existence of possible nonlinearity in the behavior of the Central Bank of Tunisia (CBT) in response to changes in macroeconomic variables over 2000:1-2018:12 period (pre-and post-2011 revolution). We used a general model with asymmetric loss function, which enables Central Bankers to weight differently positive and negative deviations of inflation and output from their reference values, as well as a nonlinear economic structure. The empirical analysis reveals that in the pre-revolutionary period, the CBT, for the sake of financial stability approved asymmetric preferences only toward the inflation rate in the sense that it reduces interest rate by a larger amount when inflation is expected to be below the target than the amount it will increase it when it is expected to be above target. During the post-revolutionary period, which was marked by a severe economic recession, the CBT also showed asymmetric preferences toward the output stabilization as it reacted more vigorously to recession. Nevertheless, for a sufficiently large inflation pressure strengthened by the nonlinear economic structure, the CBT is obliged to enhance sharply the political instrument and to carry out a strict restrictive monetary policy.