Determinants of Central Bank’s Decision on Policy Interest Rate under Inflation Targeting
Abstract
This paper aims to analyze the determination of the policy interest rate and to explain an impact of macroeconomic factors on a change in monetary policy decision. The ordered probit model under the Taylor rule is employed to capture the discrete nature of policy interest rate by using monthly data from January 2000 to July 2011 in South Korea, Thailand and the Philippines. The results indicate that the explaining and predicting of the decisions are relative to the Taylor-type variables, such as inflation gap, output growth and exchange rate. In addition, the world crude oil price, the federal fund rate and the exchange rate are added in our model in case of Thailand and the Philippines as important factors in decision making processes. In general, the ordered probit model also permits to analyze the prediction of probability in three possible outcomes of interest rate. The main finding is that the effects of fundamental variable on policy interest rate such as inflation gap is insignificant in South Korea. In this context, we found the marginal effects of the federal fund rate are higher in absolute terms for Thailand and the Philippines. In conclusion, this study is a way of understanding monetary policy. However, it is important to keep in mind that monetary policy is isolated from other external factors beyond the control of monetary policy so operating the decision-making process is not simple.
References
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2.Heij, C., De Boer, P., Frances, P. H., Kloek, T., & Van Dijk, H. K. (2004). Econometric Methods with Applications in Business and Economics. New York: Oxford University Press.
3.Long, J. S. (1997). Regression Models for Categorical and Limited Dependent Variables. Thousand Oaks, CA: Sage Publications.
Verbeek, M. (2004). A Guide to Modern Econometrics. 2nd ed. New York: John Wiley & Sons.
4.Walsh, C. E. (2003). Monetary Theory and Policy. 2nd ed. Massachusetts: MIT Press.
Article in Journal:
1Boes, S. (2007). Three essays on the econometric analysis of discrete dependent Variables. Unpublished doctoral dissertation, Universität Zürich, Faculty of Economics.
2.Butler, J. S., & Moffitt, R. (1982). A Computationally efficient quadrature procedure for the one-factor multinomial probit model. Econometrica, 50, 761-764.
3.Caetano, S., & Silva, G. Jr. (2007). Dynamics of the SELIC interest rates target in Brazil. Economics Bulletin, 5(19), 1-12.
4.Caglayan, E., & Astar, M. (2010). Taylor rule: Is it an applicable guide for inflation targeting countries?. Journal of Money, Investment and Banking, 18, 55-67.
5.Calvo, G. A., & Reinhart, C. M. (2002). Fear of floating. Quarterly Journal of Economics, 117, 379-408.
6.Clarida, R., Gali, J., & Gertler, M. (2000). Monetary policy rules and macroeconomic stability: Evidence and some theory. Quarterly Journal of Economics, 115, 147-180.
7.Davutyan, N., & Parke, W. R. (1995). The operations of the bank of England 1890-1908: A dynamic probit approach. Journal of Money, Credit and Banking, 27, 1099-1112.
8.Eichengreen, B., Watson, M., & Grossman, R. S. (1985). Bank rate policy under the interwar gold standard: A dynamic probit approach. Economic Journal, 95, 725-745.
9.Elliott, G., Rothenberg, T. J., & Stock, J. H. (1996). Efficient tests for an autoregressive unit root. Econometrica, Econometric Society, 64, 813-836.
10.Gerlach, S. (2007). Interest rate setting by the ECB, 1999-2006: Words and deeds. International Journal of Central Banking, International Journal of Central Banking, 3(3), 1-46.
11.Gorter, J., Jacobs, J., & Haan J. d. (2008). Taylor rules for the ECB using expectations data. Scandinavian Journal of Economics, 110, 473-488.
12.Greene , W. H., & Hensher, D. A. (2008). Modeling ordered choices: A primer and recent developments [Working Papers 08-26]: New York University, Leonard N. Stern School of Business, Department of Economics.
13.Hayo, B., & Neuenkirch, M. (2009). Canadian interest rate setting: The information content of Canadian and U.S. central bank communication. [MAGKS Papers on Economics 200935]: Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics.
14.Heinemann, F., & Ullrich, K. (2007). Does it pay to watch central bankers’ lips? The information content of ECB wording. Swiss Journal of Economics and Statistics (SJES), 143, 155-185.
15.Hu, L., & Phillips, Peter C. B. (2004). Dynamics of the Federal funds target rate: A nonstationary discrete choice approach. Journal of Applied Econometrics, 19, 851-867.
16.Jansen, D.-J., & Haan, J. D. (2009). Has ECB communication been helpful in predicting interest rate decisions? An evaluation of the early years of the Economic and Monetary Union. Applied Economics, 41,1995-2003.
17.Judd, J. P., & Rudebusch, G. D. (1998). Taylor's rule and the Fed, 1970-1997. Economic Review, Federal Reserve Bank of San Francisco, 3, 3-16.
18.Kim, H., Jackson, J., & Saba, R. P. (2009). Forecasting the FOMC's interest rate setting behavior: A further analysis. Journal of Forecasting, 28(2), 145-165.
19.Kim, T.-H. , Mizen, P., & Chevapatrakul, T. (2008). Forecasting changes in UKinterest rates. Journal of Forecasting, 27, 53-74.
20.Kwiatkowski, D., Phillips, P. C. B., Schmidt, P., & Shin, Y. (1992). Testing the null hypothesis of stationarity against the alternative of a unit root: How sure are we that economic time series have a unit root? Journal of Econometrics, 54, 159-178.
21.Lapp, J. S., Pearce, D. K., & Laksanasut, S. (2003). The predictability of FOMC decisions: Evidence from the Volcker and Greenspan chairmanships. Southern Economic Journal, 70(2), 312-327.
22.Luangaram, Pongsak, Sethapramote, Yuthana, & Sirisettaapa, Pimolrat. (2009, November). An evaluation of inflation forecast targeting in Thailand. BOT Research Workshop 4-6.
23.Mehra, Y. P., & Sawhney, B. (2010). Inflation measure, Taylor rules, and the Greenspan-Bernanke years. Economic Quarterly, Federal Reserve Bank of Richmond, 96(2), 123-151.
24.Mishkin, F. S. (2007). Headline versus core inflation in the conduct of monetary policy: a speech at the Business Cycles, International Transmission and Macroeconomic Policies Conference, HEC Montreal, Montreal, Canada, Oc. Speech, Board of Governors of the Federal Reserve System (U.S.).
25.Moura, M. L., & de Carvalho, A. (2010). What can Taylor rules say about monetary policy in Latin America?. Journal of Macroeconomics, 32, 392-404.
26.Newey, W. K., & West, K. D. (1994). Automatic lag selection in covariance matrix estimation. Review of Economic Studies, Wiley Blackwell, 61, 631-653.
27.Ng, S., & Perron, P. (2000). Lag length selection and the construction of unit root tests with good size and power. Econometrica, 69, 1519-1554.
28.Phillips, Peter C. B., Jin, S., & Hu, L. (2007). Nonstationary discrete choice: A corrigenda. Journal of Econometrics, 141, 1115-1130.
29.Rosa, C. (2009). Forecasting the direction of policy rate changes: The importance of ECB words. Economic Notes, 38, 39-66.
30.Rudebusch, G. D. (2002). Term structure evidence on interest rate smoothing and monetary policy inertia. Journal of Monetary Economics, Elsevier, 49(6), 1161-1187.
31.Ruth, K. (2007). Interest rate reaction functions for the euro area. Empirical Economics, 33, 541-569.
32.Sack, B., & Wieland, V. (2000). Interest rate smoothing and optimal monetary policy: A review of recent empirical evidence. Journal of Economics and Business, 52, 205-228.
33.Svensson, Lars E. O. (1997). Inflation forecast targeting: Implementing and monitoring inflation targets. European Economic Review, 41, 1111-1146.
34.Taylor, J. (1993). Discrete versus policy rules in practice. Carnegie–Rochester Series on Public Policy, 39, 195-214.
35.Woodford, M. (2001). The Taylor rule and optimal monetary policy. American Economic Review. 91, 232-237.
1.Greene, W. H. (2003). Econometric Analysis. 5th ed. Upper Saddle River, NJ: Prentice Hall.
2.Heij, C., De Boer, P., Frances, P. H., Kloek, T., & Van Dijk, H. K. (2004). Econometric Methods with Applications in Business and Economics. New York: Oxford University Press.
3.Long, J. S. (1997). Regression Models for Categorical and Limited Dependent Variables. Thousand Oaks, CA: Sage Publications.
Verbeek, M. (2004). A Guide to Modern Econometrics. 2nd ed. New York: John Wiley & Sons.
4.Walsh, C. E. (2003). Monetary Theory and Policy. 2nd ed. Massachusetts: MIT Press.
Article in Journal:
1Boes, S. (2007). Three essays on the econometric analysis of discrete dependent Variables. Unpublished doctoral dissertation, Universität Zürich, Faculty of Economics.
2.Butler, J. S., & Moffitt, R. (1982). A Computationally efficient quadrature procedure for the one-factor multinomial probit model. Econometrica, 50, 761-764.
3.Caetano, S., & Silva, G. Jr. (2007). Dynamics of the SELIC interest rates target in Brazil. Economics Bulletin, 5(19), 1-12.
4.Caglayan, E., & Astar, M. (2010). Taylor rule: Is it an applicable guide for inflation targeting countries?. Journal of Money, Investment and Banking, 18, 55-67.
5.Calvo, G. A., & Reinhart, C. M. (2002). Fear of floating. Quarterly Journal of Economics, 117, 379-408.
6.Clarida, R., Gali, J., & Gertler, M. (2000). Monetary policy rules and macroeconomic stability: Evidence and some theory. Quarterly Journal of Economics, 115, 147-180.
7.Davutyan, N., & Parke, W. R. (1995). The operations of the bank of England 1890-1908: A dynamic probit approach. Journal of Money, Credit and Banking, 27, 1099-1112.
8.Eichengreen, B., Watson, M., & Grossman, R. S. (1985). Bank rate policy under the interwar gold standard: A dynamic probit approach. Economic Journal, 95, 725-745.
9.Elliott, G., Rothenberg, T. J., & Stock, J. H. (1996). Efficient tests for an autoregressive unit root. Econometrica, Econometric Society, 64, 813-836.
10.Gerlach, S. (2007). Interest rate setting by the ECB, 1999-2006: Words and deeds. International Journal of Central Banking, International Journal of Central Banking, 3(3), 1-46.
11.Gorter, J., Jacobs, J., & Haan J. d. (2008). Taylor rules for the ECB using expectations data. Scandinavian Journal of Economics, 110, 473-488.
12.Greene , W. H., & Hensher, D. A. (2008). Modeling ordered choices: A primer and recent developments [Working Papers 08-26]: New York University, Leonard N. Stern School of Business, Department of Economics.
13.Hayo, B., & Neuenkirch, M. (2009). Canadian interest rate setting: The information content of Canadian and U.S. central bank communication. [MAGKS Papers on Economics 200935]: Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics.
14.Heinemann, F., & Ullrich, K. (2007). Does it pay to watch central bankers’ lips? The information content of ECB wording. Swiss Journal of Economics and Statistics (SJES), 143, 155-185.
15.Hu, L., & Phillips, Peter C. B. (2004). Dynamics of the Federal funds target rate: A nonstationary discrete choice approach. Journal of Applied Econometrics, 19, 851-867.
16.Jansen, D.-J., & Haan, J. D. (2009). Has ECB communication been helpful in predicting interest rate decisions? An evaluation of the early years of the Economic and Monetary Union. Applied Economics, 41,1995-2003.
17.Judd, J. P., & Rudebusch, G. D. (1998). Taylor's rule and the Fed, 1970-1997. Economic Review, Federal Reserve Bank of San Francisco, 3, 3-16.
18.Kim, H., Jackson, J., & Saba, R. P. (2009). Forecasting the FOMC's interest rate setting behavior: A further analysis. Journal of Forecasting, 28(2), 145-165.
19.Kim, T.-H. , Mizen, P., & Chevapatrakul, T. (2008). Forecasting changes in UKinterest rates. Journal of Forecasting, 27, 53-74.
20.Kwiatkowski, D., Phillips, P. C. B., Schmidt, P., & Shin, Y. (1992). Testing the null hypothesis of stationarity against the alternative of a unit root: How sure are we that economic time series have a unit root? Journal of Econometrics, 54, 159-178.
21.Lapp, J. S., Pearce, D. K., & Laksanasut, S. (2003). The predictability of FOMC decisions: Evidence from the Volcker and Greenspan chairmanships. Southern Economic Journal, 70(2), 312-327.
22.Luangaram, Pongsak, Sethapramote, Yuthana, & Sirisettaapa, Pimolrat. (2009, November). An evaluation of inflation forecast targeting in Thailand. BOT Research Workshop 4-6.
23.Mehra, Y. P., & Sawhney, B. (2010). Inflation measure, Taylor rules, and the Greenspan-Bernanke years. Economic Quarterly, Federal Reserve Bank of Richmond, 96(2), 123-151.
24.Mishkin, F. S. (2007). Headline versus core inflation in the conduct of monetary policy: a speech at the Business Cycles, International Transmission and Macroeconomic Policies Conference, HEC Montreal, Montreal, Canada, Oc. Speech, Board of Governors of the Federal Reserve System (U.S.).
25.Moura, M. L., & de Carvalho, A. (2010). What can Taylor rules say about monetary policy in Latin America?. Journal of Macroeconomics, 32, 392-404.
26.Newey, W. K., & West, K. D. (1994). Automatic lag selection in covariance matrix estimation. Review of Economic Studies, Wiley Blackwell, 61, 631-653.
27.Ng, S., & Perron, P. (2000). Lag length selection and the construction of unit root tests with good size and power. Econometrica, 69, 1519-1554.
28.Phillips, Peter C. B., Jin, S., & Hu, L. (2007). Nonstationary discrete choice: A corrigenda. Journal of Econometrics, 141, 1115-1130.
29.Rosa, C. (2009). Forecasting the direction of policy rate changes: The importance of ECB words. Economic Notes, 38, 39-66.
30.Rudebusch, G. D. (2002). Term structure evidence on interest rate smoothing and monetary policy inertia. Journal of Monetary Economics, Elsevier, 49(6), 1161-1187.
31.Ruth, K. (2007). Interest rate reaction functions for the euro area. Empirical Economics, 33, 541-569.
32.Sack, B., & Wieland, V. (2000). Interest rate smoothing and optimal monetary policy: A review of recent empirical evidence. Journal of Economics and Business, 52, 205-228.
33.Svensson, Lars E. O. (1997). Inflation forecast targeting: Implementing and monitoring inflation targets. European Economic Review, 41, 1111-1146.
34.Taylor, J. (1993). Discrete versus policy rules in practice. Carnegie–Rochester Series on Public Policy, 39, 195-214.
35.Woodford, M. (2001). The Taylor rule and optimal monetary policy. American Economic Review. 91, 232-237.
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Published
2018-07-25
How to Cite
หนูสุวรรณ จ. (2018). Determinants of Central Bank’s Decision on Policy Interest Rate under Inflation Targeting. Thailand and The World Economy, 30(1), 84–128. Retrieved from https://so05.tci-thaijo.org/index.php/TER/article/view/136515
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