Changes In Monetary Policy Regimes Research Articles

Determinants of Monetary Policy: An Application of Regime Switching Model

The monetary policy of India has undergone substantial changes since 2013, particularly after taper tantrum episodes. The RBI moved from WPI to CPI for measuring inflation. Monetary policy anchoring shifted from a multiple-indicator approach (MIA) to flexible inflation targeting (FIT) in 2016 to deal with the aftermath of the global financial crisis. In this context, the study examined whether there was a significant shift in the monetary policy regime using a non-linear model (Markov Switching-Vector Autoregression Model) covering monthly data from 2013 to 2020. The study also investigated the role of the inflation rate, oil price, growth rate, and exchange rate in influencing monetary policy in India. The study found no change in the RBI monetary policy regime, and monetary policy remained biased towards controlling the inflation rate.

Dynamic Expectations Formation and U.S. Monetary Policy Regime Change

This essay studies the fundamental causes of the monetary policy regime switches within rational expectations models. I introduce a threshold-switching monetary policy process into the model that links the policy stance to the fundamental shocks by an autoregressive regime strength index. It creates an expectations feedback mechanism between private agents’ policy forecasts and future policy regime outcomes. As demonstrated in a novel threshold-switching Fisherian model, well management of the private sector’s expectations of policy regime change can have the same effect as actually switching the regime. Contrastingly, failure to do so leads to unfavorable outcomes of policy intention. Then, I embed the new mechanism into a New Keynesian model. Along the way, I also develop an efficient non-simulation based threshold-switching Kalman filter, in conjunction with a solution method that accounts for the endogeneity of switching regimes, to estimate the nonlinear New Keynesian model. My key empirical findings are threefold. First, non-policy shocks have been instrumental in driving U.S. monetary policy regime changes during the post-World War II period. Most notably, markup shock explains 65.6% of variations in the policy regimes. Second, absent from markup shocks, eight of the eleven less aggressive regimes would not have happened during this history. Finally, I conclude that linking the private sector’s dynamic expectations formation and the Fed’s dilemma of the dual mandate in the presence of adverse supply shocks is a promising path towards providing micro-foundations for monetary policy regime shifts.

The transition of China's monetary policy regime: Before and after the four trillion RMB stimulus

This paper studies the monetary policy of China in a flexible time-varying parameter vector autoregression model with stochastic volatility, with a focus on the monetary policy regime change around 2009 when the four trillion RMB stimulus started. We find that China has been transiting from targeting money quantity to targeting interest rate since 2009. The interest rate policy instrument played a bigger role in the central bank's monetary policy toolbox. We check an alternative identification strategy and a couple of different model settings to show the robustness of this conclusion.

A NON-LINEAR ANALYSIS OF GIBSON’S PARADOX

Keynes (1930) considered the Gibson’s relation as “most completely established empirical fact”. In contrast to the previous literature, this paper adopts a multivariate, nonlinear framework to analyse Gibson’s paradox in the Netherlands over the period 1800-2012. Specifically, SSA (Singular Spectrum Analysis) and MSSA (Multichannel Singular Spectrum Analysis) techniques are used. It is shown that changes in monetary policy regimes or volatility in the price of gold by themselves cannot account for the behaviour of government bond yields and prices over the last 200 years. However, the inclusion of changes in the real rate of return on capital, M1, primary credit rate, expected inflation, and money purchasing power enables a nonlinear model to account for a sizeable percentage of the total variance of Dutch bond yields. This is a novel study of the Gibson’s paradox using a non-linear approach unravelling the multidimensional nature of the paradox. The results should assist policy makers in setting monetary policy and help to better understand the behaviour of financial institutions on the markets. Central banks, should however evaluate the implication of this study in setting inflation targeting goals. Results of this study are also expected to stimulate further research on the bank credit policies by managing interest rates.DOI: http://dx.doi.org/10.5755/j01.ee.29.4.20403

Modeling the real ruble exchange rate under monetary policyregime change

The paper estimates vector error correction model (VECM) for the real ruble exchange rate and real oil prices. The VECM model takes into account the structural break in short-term parameters due to the Bank of Russia monetary policy regime change in November 2014. Estimates show that the real exchange rate response to oil price shocks has dramatically changed. Before November2014 it took approximately one year to correct 50% of the real exchange rate gap due to oil prices permanent change. From November 2014 the real exchange rate adapts to oil price shocks almost instantly. The estimate of long-run elasticity of the real exchange rate on real oil prices is 0.33.

Inflation dynamics and agricultural supply shocks in Uganda

Purpose The purpose of this paper is to develop an empirical model for inflation in Uganda, highlighting the role of supply side factors in the domestic agricultural sector. Design/methodology/approach The adopted empirical analysis is based on a single equation model that exploits cointegration techniques and general-to-specific modeling. The analysis controls for historical, seasonal as well as policy factors such as the effects of the global financial crisis, change in monetary policy regime to inflation targeting and monthly seasonal effects. Findings Results indicate that disequilibrium in the money, external and agricultural sectors feed into the Ugandan inflation process in the long run. However, the external and monetary sectors have larger long-run effects on inflation than the agricultural sector. Other factors that influence inflation in the short run include: inflation inertia, real output, money supply, exchange rate movements, foreign prices, monetary policy instruments and seasonal factors. In addition, the paper shows that the inflation-targeting policy has been successful in containing inflationary pressures. Practical implications These findings suggest that in the long-run monetary policy will continue to play an important role in managing Ugandan inflation through money demand management. The inflationary effects of agricultural supply shocks could be mitigated with appropriate domestic actions. In particular, fiscal policy that targets increased productivity and efficiency in agriculture through increased focus on production, irrigation, storage and transportation could reduce the effects of agricultural supply variability on inflation. In addition, policies intended to improve economic growth by expanding total output, control money supply growth and maintaining stability in the foreign exchange markets will help to reduce inflation. Social implications Studies of inflation and its determinants have dominated macroeconomic debates in the past decades because of the importance of price stability in economic growth and household welfare. The major conclusions from those studies are that: high inflation is detrimental to investment and growth; erodes the purchasing power; reduces household welfare; and exacerbates income inequality. Moreover there is a growing strand of literature establishing a causal link between inflation and conflict. Particularly for agricultural households, the effects of inflation are usually felt through the increase in food prices with implications for consumption and food security. These findings indicate the important macro and social implications of inflation. By focusing on the importance of agricultural supply shocks, the paper contributes to a better understanding of the drivers of inflation and how the macro and social effects can be addressed. Originality/value The major contribution of this paper is to try and model an equilibrium relationship in the domestic agricultural sector rather than using proxies such as an output gap measure or rainfall.

Monetary policy regime change and regional inflation dynamics: looking through the lens of sector‐level data for Korea

AbstractThis paper explores the impact of the adoption of inflation targeting (IT) on the dynamics of city‐level inflation in Korea using both aggregate and sector‐level data. When looking at aggregate regional inflation, we find that the mean, volatility and persistence fell in all cities in the wake of the monetary policy regime change, consistent with other evidence in the literature. Delving more deeply into the disaggregate data reveals additional insights however. For most of the changes we observe in the dynamics of regional inflation, we find that the aggregate effects are being driven primarily by sectors that fall into the ‘Services’ category. We posit that the impact of better anchored inflationary expectations is primarily on the less‐traded services sectors of the economy, where the domestic monetary policy framework has a relatively larger influence. When it comes to the increased co‐movement observed across regions under an IT regime, however, it is the ‘Commodities’ sectors rather than ‘Services’ that are responsible, probably because services inflation becomes relatively more influenced by local factors once it has stabilized within the target range. Therefore, adoption of IT may not necessarily increase all measures of regional synchronization even when the goal of better‐anchored inflationary expectations is achieved.

Monetary Policy in a Markov-Switching VECM: Implications for the Cost of Disinflation in Ghana

Monetary policy assessment in Ghana has been conducted using vector auto-regression. This however, presumes stability of long run outcomes and particularly ignores monetary policy regime changes that has characterized the economy overtime. This study thus introduced the possibility of switches in the long run equilibrium in co-integrated vector auto-regression by allowing both the covariance and weighting matrix in the error-correction term to switch. The study did not find any significant difference in monetary response in the different states. However, significant difference was obtained for the cost of disinflation across states. Though, disinflation cost has declined as the Bank of Ghana shifts from monetary targeting to inflation-targeting regime, overall cost is still high. This has implication on disinflation policy given the development agenda pursue by the country.

Monetary Policy Regime Change and Regional Inflation Dynamics: Looking Through the Lens of Sector-Level Data for Korea

This paper explores the impact of the adoption of inflation targeting (IT) on the dynamics of city-level inflation in Korea using both aggregate and sector-level data. When looking at aggregate regional inflation, we find that the mean, volatility and persistence fell in all cities in the wake of the monetary policy regime change, consistent with other evidence in the literature. We also note a narrowing of the dispersion of regional inflation across cities and a greater degree of regional co-movement. Delving more deeply into the disaggregate data reveals additional insights however. For most of the changes we observe in the dynamics of regional inflation, we find that the aggregate effects are being driven primarily by sectors that fall into the ‘Services’ category. We posit that the impact of better anchored inflationary expectations is primarily on the less-traded services sectors of the economy, where the domestic monetary policy framework has a relatively larger influence compared with globally-traded commodities. When it comes to the increased co-movement observed across regions under IT regime, however, it is the ‘Commodities’ sectors rather than ‘Services’ that are responsible, probably because services inflation becomes relatively more influenced by local factors once it has stabilized within the target range. We show that this sectoral heterogeneity can be explained by the difference in price stickiness such that sectors in which prices are adjusted less frequently tend to have a larger response under the new monetary policy regime.

The effects of monetary policy regime shifts on the term structure of interest rates

AbstractWe investigate how the entire term structure of interest rates is influenced by changes in monetary policy regimes. To do so, we develop and estimate an arbitrage-free dynamic term-structure model which accounts for regime shifts in monetary policy and price of risk. Our results for US data from 1985 through 2008 indicate that (

Level shifts in stock returns driven by large shocks

Abstract This paper employs a parametric model of persistent (level) shifts in the conditional mean of stock market returns which are endogenously driven by large positive or negative return shocks. These shocks can be taken to reflect important market announcements, monetary policy regime changes and/or changes in business conditions affecting stock market. The model assumes that both the timing and size of breaks are stochastic. The last property of the model distinguishes it from other nonlinear models of the literature employed to capture level shifts in stock returns. Implementation of the model to the US stock market indicates that it can successfully capture level shifts in the mean of the aggregate return of this market which follow a cyclical pattern. Most of these shifts are triggered by negative large return shocks. The latter can be of smaller magnitude than that of the positive ones. Finally, the paper shows that the model can be employed to successfully forecast future expected stock returns.

Is forecasting inflation easier under inflation targeting?

This paper investigates whether monetary-policy regime changes affect the success of forecasting inflation. The forecasting performances of some linear and nonlinear univariate models are analyzed for 14 different countries that have adopted inflation-targeting (IT) monetary regimes at some point in their economic history. The results show that forecasting performance is generally superior under an IT monetary regime compared to nonIT (NIT) periods. In more than half of the countries covered in this study, superior forecasting accuracy can be achieved in IT periods regardless of the model used. In contrast, among most of the remaining countries, the results remain ambiguous, and the evidence on the superiority of NIT is limited to very few countries.

Structural Breaks in Stock Returns Driven by Large Shocks

This paper employes a parametric model of structural breaks in the mean of stock returns which allows them to be endogenously driven by large positive or negative stock market return shocks. These shocks can be taken to reflect important market announcements, monetary policy regime shifts and/or changes in business conditions which affect stock market. The model assumes that both the timing and size of breaks are stochastic. The last property of the model distinguishes it from models suggested in the literature to capture structural breaks or regime shifts in the mean of stock returns. Implementation of the model to the US stock market indicates that the model can successfully capture structural breaks in the mean of the aggregate return of this market. Most of these breaks are triggered by negative large return shocks. The latter can be of smaller magnitude that the positive ones. Finally, the paper shows that the model can be employed to successfully forecast future expected stock returns.

Dove or Hawk? Characterizing monetary policy regime switches in India

The past two decades have witnessed a worldwide move by emerging markets to adopt explicit or implicit inflation targeting regimes. A notable and often discussed exception to this trend, of course, is China which follows a pegged exchange rate regime supported by capital controls. Another major exception is India. It is not clear how to characterize the monetary regime or identify the nominal monetary anchor in India. Is central bank policy in India following a predictable rule that is heavily influenced by a quasi inflation target? And how has the monetary regime been affected by the gradual process of financial liberalization in India? To address these points, we investigate monetary policy regime change in India using a Markov switching model to estimate a time-varying Taylor-type rule for the Reserve Bank of India. We find that the conduct of monetary policy over the last two decades can be characterized by two regimes, which we term ‘Hawk’ and ‘Dove.’ In the first of these two regimes, the central bank reveals a greater relative (though not absolute) weight on controlling inflation vis-à-vis narrowing the output gap. The central bank however was found to be in the “Dove” regime about half of our sample period, focusing more on the output gap and exchange rate targets to stimulate exports, rather than moderating inflation. India thus seems to be following its own direction in the conduct of monetary policy, seemingly not overly influenced by the emphasis on quasi-inflation targeting seen in many emerging markets.

Heterogeneous response of disaggregate inflation to monetary policy regime change: The role of price stickiness

This paper explores how a monetary regime change affects headline inflation via differential effects on various sectors in the economy. Using disaggregated CPI data for Canada, we find that the response to the adoption of inflation targeting (IT) was quite heterogeneous across sectors. While sticky-price sectors experienced a notable change in inflation dynamics following IT adoption, little structural change was observed in flexible price sectors. Our analysis based on a common factor model suggests that the structural changes in the sticky price sectors are driven by a decline in their responses to common aggregate shocks, including a monetary shock.

Monetary transmission in three central European economies: evidence from time-varying coefficient vector autoregressions

We study the transmission of monetary policy to macroeconomic variables with structural time-varying coefficient vector autoregressions in the Czech Republic, Hungary and Poland, in comparison with that in the euro area. These three countries have experienced changes in monetary policy regimes and went through substantial structural changes, which call for the use of a time-varying parameter analysis. Our results indicate that the impact on output of a monetary shock changed over time. At the point of the last observation of our sample, the fourth quarter of 2011, among the three countries, monetary policy was most powerful in Poland and not much less strong than the transmission in the euro area. We discuss various factors that can contribute to differences in monetary transmission, such as financial structure, labour market rigidities, industry composition, exchange rate regime, credibility of monetary policy and trade openness.

Heterogeneous Response of Disaggregate Inflation to Monetary Policy Regime Change: What Can Be Learned from Canada’s Adoption of Inflation Targeting?

This paper explores the impact of monetary policy regime change on sectoral and regional inflation by analyzing the case of Canada and its adoption of inflation targeting (IT). Using disaggregated CPI data for Canada from 1978, we find that responses to the change in the monetary policy framework are quite heterogeneous, particularly across sectors. While inflation series in the traditionally volatile commodity sectors exhibit weak responses to the regime change, those in the so-called core sectors are highly responsive. This pattern is evident in both national and provincial level data, indicating that it is the core sectors that are crucial for the transmission of a monetary policy regime change. Further analysis based on a common factor model reveals that common shocks, such as those associated with the monetary policy framework, account for only a small portion of the variation in sectoral inflation, and that their relative importance has decreased after IT adoption in many core sectors. Interestingly, considerable variation exists even across the core sectors in the strength of the regime change effect. We document that this heterogeneity is meaningfully correlated with some measurable sector-specific characteristics; sectors with a lower degree of prices stickiness and a lower degree of tradability appear more sensitive to the change in monetary policy regime.

ARDL bounds tests and robust inference for the long run relationship between real stock returns and inflation in Australia

This paper conducts an empirical investigation into the long run relationship between real stock returns and inflation in Australia by employing the ARDL bounds tests. There exists a stock return–inflation long run relationship, and the long run parameters are non-linear functions of those of the conditional error correction model. The OLS estimates of the latter model constitute the long run parameter estimates and their standard errors are estimated by delta methods. The long run model estimates so constructed can be biassed and inconsistent, and the delta method is derived assuming asymptotic normality, which does not hold in this investigation. In this paper, to overcome these limitations of the traditional methods, we employ the bias-corrected bootstrap method. As a consequence, the robust and reliable statistical inference can be made on the long run return–inflation relationship. The empirical results show that the expected inflation had no significant effect on real stock returns, while the observed inflation had a significant and negative effect. Furthermore, the data generating process of the returns–inflation relationship was not affected by the change in monetary policy regime in the early 1990s. These findings imply that Australian stocks have been very effective instruments for hedging against expected inflation. Because of the resilience of Australian economy to the current global financial and economic crisis, this finding has implications for long term domestic and foreign investors in Australia.

Dove or Hawk? Characterizing Monetary Policy Regime Switches in India

The past two decades have witnessed a worldwide move by emerging markets to adopt explicit or implicit inflation targeting regimes. A notable and often discussed exception to this trend, of course, is China which follows pegged exchange rate regime supported by capital controls. Another major exception is India. It is not clear how to characterize the monetary regime or identify the nominal monetary anchor in India. Is central bank policy in India following a predictable rule that is heavily influenced by a quasi inflation target? And how has the monetary regime been affected by the gradual process of financial liberalization in India? To address these points, we investigate monetary policy regime change in India using a Markov switching model to estimate a time-varying Taylor-type rule for the Reserve Bank of India. We find that the conduct of monetary policy over the last two decades can be characterized by two regimes, which we term ‘Hawk’ and ‘Dove.’ In the first of these two regimes, the central bank reveals a greater relative (though not absolute) weight on controlling inflation vis-a-vis narrowing the output gap. The central bank however was found to be in the “Dove” regime about half of our sample period, focusing more on the output gap and exchange rate targets to stimulate exports, rather than on moderating inflation. India thus seems to be following its own direction in the conduct of monetary policy, seemingly not overly influenced by the emphasis on quasi-inflation targeting seen in many emerging markets.

The Effects of Monetary Policy Regime Shifts on the Term Structure of Interest Rates

We investigate how the entire term structure of interest rates is influenced by changes in monetary policy regimes. To do so, we develop and estimate an arbitrage-free dynamic term-structure model which accounts for regime shifts in monetary policy, volatility, and the price of risk. Our results for U.S. data from 1985-2008 indicate that (i) the Fed's reaction to inflation has changed over time, switching between active'' and less active'' monetary policy regimes, (ii) on average, the slope of the yield curve in the active'' regime was steeper than in the less active'' regime, and (iii) the yield curve in the active'' regime was considerably more volatile than in the less active'' regime. The steeper yield curve in the active'' regime appears to reflect higher term premia that result from the risk associated with a more volatile future short-term interest rate given a more sensitive response to inflation.