Abstract
We examine the evolution of monetary policy rules in a group of inflation targeting countries (Australia, Canada, New Zealand, Sweden and the United Kingdom), applying a time-varying parameter model with endogenous regressors. Our main findings are threefold.
First, monetary policy rules change gradually, pointing to the importance of applying a time-varying estimation framework. Second, the interest rate smoothing parameter is much lower than typically reported by previous time-invariant estimates of policy rules.
Third, the response of interest rates to inflation is particularly strong during periods when central bankers want to break a record of high inflation. Contrary to common wisdom, the response becomes less aggressive after the adoption of inflation targeting, suggesting a positive anchoring effect of this regime on inflation expectations.
This result is supported by our finding that inflation persistence as well as the policy neutral rate decreased after the adoption of inflation targeting.