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SWITCHING TO GOOD POLICY? THE CASE OF CENTRAL AND EASTERN EUROPEAN INFLATION TARGETERS

Published online by Cambridge University Press:  10 April 2019

Andrej Drygalla
Andrej Drygalla*
Affiliation:
Halle Institute for Economic Research (IWH)
*
Address correspondence to: Andrej Drygalla, Halle Institute for Economic Research (IWH), Kleine Maerkerstrasse 8, 06108 Halle (Saale), Germany. e-mail: [email protected]. Phone: +49 345 7753 812.
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Abstract

The paper analyzes how actual monetary policy changed following the official adoption of inflation targeting in the Czech Republic, Hungary, and Poland and how it affected the volatilities of important macroeconomic variables in the years thereafter. To disentangle the effects of the policy shift from exogenous changes in the volatilities of these variables, a Markov-switching dynamic stochastic general equilibrium model is estimated that allows for regime switches in the policy parameters and the volatilities of shocks hitting the economies. Whereas estimation results reveal periods of high and low volatility for all three economies, the presence of different policy regimes is supported by the underlying data for the Czech Republic and Poland, only. In both economies, monetary policy switched from weak and unsystematic to strong and systematic responses to inflation dynamics. Simulation results suggest that the policy shifts of both central banks successfully reduced inflation volatility in the following years. The observed reduction in output volatility, on the other hand, is attributed more to a reduction in the size of external shocks.

Keywords

Markov-Switching DSGE ModelsInflation TargetingSmall Open Economy
Type
Articles
Information
Macroeconomic Dynamics , Volume 24 , Issue 8 , December 2020 , pp. 2104 - 2128
Copyright
© 2019 Cambridge University Press

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Footnotes

The author would like to thank Boris Blagov, Makram El-Shagi, Oliver Holtemöller, Tomáš Holub, Axel Lindner, Galina Potjagailo, Mathias Trabandt, two anonymous referees, and the participants at conferences in Leipzig and Prague, the INFER Workshop in Timisoara and seminars at the Halle Institute for Economic Research for their helpful comments.

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