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Do central banks respond to exchange rates and restrictions to capital flows? Evidence from panel data

Åkesson, Anna LU (2014) NEKN01 20141
Department of Economics
Abstract
This paper examines whether central banks consider exchange rates and restrictions to capital flows when setting the policy rate. Specifically, this paper studies if there is a difference in the reaction between inflation targeting central bank and non-inflation targeting central banks in advanced and emerging economies. The recent financial crisis is also covered, that is, did the crisis change whether central banks are considering movements in the exchange rate as well as restrictions to capital flows as determinants of their policy rate. Using a linear monetary policy reaction function where the short-term interest rate reacts to expected future inflation deviation, output-gap and real exchange rate fluctuations. Then in order to... (More)
This paper examines whether central banks consider exchange rates and restrictions to capital flows when setting the policy rate. Specifically, this paper studies if there is a difference in the reaction between inflation targeting central bank and non-inflation targeting central banks in advanced and emerging economies. The recent financial crisis is also covered, that is, did the crisis change whether central banks are considering movements in the exchange rate as well as restrictions to capital flows as determinants of their policy rate. Using a linear monetary policy reaction function where the short-term interest rate reacts to expected future inflation deviation, output-gap and real exchange rate fluctuations. Then in order to investigate the effect of restrictions to capital flows (as measured by the Schindler index) on central bank’s exchange rate policy, these variables are included in the policy function. A panel data set of 48 inflation targeting and non-targeting is employed, and the empirical results suggest that short-term interest rates in both advanced and emerging inflation targeting countries react to real exchange rate deviations and foreign interest rates. When the whole sample period is considered no significant response to the restriction variables is found, however when the sample period is divided in to a pre- and post-crisis period a reaction to the restriction variables is found. (Less)
Please use this url to cite or link to this publication:
author
Åkesson, Anna LU
supervisor
organization
course
NEKN01 20141
year
type
H1 - Master's Degree (One Year)
subject
keywords
Inflation targeting, Taylor rule, real exchange rate, Schindler index
language
English
id
4617328
date added to LUP
2014-09-22 11:43:57
date last changed
2014-09-22 11:43:57
@misc{4617328,
  abstract     = {{This paper examines whether central banks consider exchange rates and restrictions to capital flows when setting the policy rate. Specifically, this paper studies if there is a difference in the reaction between inflation targeting central bank and non-inflation targeting central banks in advanced and emerging economies. The recent financial crisis is also covered, that is, did the crisis change whether central banks are considering movements in the exchange rate as well as restrictions to capital flows as determinants of their policy rate. Using a linear monetary policy reaction function where the short-term interest rate reacts to expected future inflation deviation, output-gap and real exchange rate fluctuations. Then in order to investigate the effect of restrictions to capital flows (as measured by the Schindler index) on central bank’s exchange rate policy, these variables are included in the policy function. A panel data set of 48 inflation targeting and non-targeting is employed, and the empirical results suggest that short-term interest rates in both advanced and emerging inflation targeting countries react to real exchange rate deviations and foreign interest rates. When the whole sample period is considered no significant response to the restriction variables is found, however when the sample period is divided in to a pre- and post-crisis period a reaction to the restriction variables is found.}},
  author       = {{Åkesson, Anna}},
  language     = {{eng}},
  note         = {{Student Paper}},
  title        = {{Do central banks respond to exchange rates and restrictions to capital flows? Evidence from panel data}},
  year         = {{2014}},
}