An essay on monetary policy asymmetry: An application on the central bank of Jordan's reaction function

Date

2014-08

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Abstract

This work estimates an expanded linear Taylor rule type model. The results show that the CBJ responds actively to the domestic policy key variables; the output gap and the inflation rate, besides the federal funds rate, as expected, given the ruling pegged exchange rate in Jordan. The work then investigates monetary policy asymmetry in Jordan using the following six threshold type models which are commonly used in the littrature: the basic threshold regression model, the opportunistic model, the full opportunistic model, the exponential smooth transition regression (ESTR) model, the logistic smooth transition (LSTR) model and the Quadratic the logistic smooth transition (LSTR2) model. Besides the previously examined statistical nonlinear models, this work extends its analysis of the nonlinear framework of Taylor rule to the structural modeling approach which models the asymmetric behavior of the CBJ, according to the source of monetary policy asymmetry; the nonlinear structure of the economy, or the asymmetric CBJ’s preferences. The estimation results of this work provide the evidence for nonlinearity in the CBJ’s behavior, and it chooses the ESTR model as the best fitting model over the 1998:3– 2013:10 period, since it tracks the CBJ’s policy interest rate dynamics better than the other baseline linear model as well as the nonlinear models explored in this work. The ESTR model suggests that the output is the only concern of the CBJ in the inner regime; when the percentage change of output relative to its potential level is around the threshold value of 1.127%, with no concern attached to the inflation rate. The results reveal that the CBJ’s policy rate is irresponsive to the changes in the federal funds rate, as in indication of more monetary policy autonomy in the inner regime. It shows also a high degree of persistence in the CBJ’s policy rate in the inner regime relative to the outer regime. On the other hand, the CBJ found to be more responsive to the fluctuations in the federal funds rate in the outer regime. Similarly, Inflation shows to be the priority of the CBJ in deep slumps or booms than around the threshold value of the output gap (the outer regime). Finally, this work provides evidence for a nonlinear and convex AS in Jordan. The revealed nonlinearity in the economic system suggests the existence of nonlinear policy rule in Jordan driven by a nonlinear structure of the economy. While the results provide no evidence for the existence of asymmetric CBJ’s preferences, although the conditional variance of inflation found to be variable and volatile.

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Keywords

Taylor's rule, Monetary policy asymmetry

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