Active and Passive Monetary Policy in CEE Countries with Inflation Targeting: The Case of the Czech Republic, Hungary, and Poland

Abstract

The concept of nonlinear Taylor rules describing behavior of the central banks becomes popular in the literature. In this paper we estimate Markov switching Taylor rules for three CEE economies: the Czech Republic, Hungary and Poland, all being inflation targeters. For the robustness purposes we estimate several different specifications of the Taylor rule: backward- and forward-looking, with inflation and inflation gap as explaining variables. As the analyzed CEE countries are small open economies additional variables are included to the standard Taylor rule: foreign interest rate and exchange rate. We find that two regimes of monetary policy may be distinguished: passive and active regime. The passive regime, which seems dominant, is characterized by strong smoothing of the interest rate path and little response to inflation and output gap developments. In the active regime the smoothing parameter decreases and the reaction to inflation and/or output gap is stronger.

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