Monetary policy reaction function in emerging economies: an empirical analysis

Abstract

This article presents the results of a comprehensive cross-country analysis of central banks’ reaction functions in eighteen emerging economies from 2000Q1 to 2017Q4. Utilizing quarterly panel data, the study employs the generalized method of moments (GMM) alongside pooled OLS and fixed-effects estimators to investigate central banks’ interest rate-setting behavior. The focus extends beyond conventional variables, incorporating external conditions into the analysis. The findings demonstrate that central banks in emerging markets adhere to an expanded Taylor rule, considering not only inflation and the output gap but also external financial conditions and commodity prices. The article concludes by suggesting policy implications derived from the empirical results, emphasizing the need for enhanced effectiveness and adaptability of monetary policy in emerging countries, accounting for both domestic and external factors. The study also proposes avenues for future research, encouraging exploration into extended forms of central bank reaction functions, including interactions with central bank independence.

Keywords

• Central bank
• reaction function
• dynamic panel data
• Econometrics
• Macroeconomics
• International Economics