Download TAYLOR RULE IN EAST ASIAN COUNTRIES

TAYLOR RULE IN EAST
ASIAN COUNTRIES
Shahdad Naghshpour
The University of Southern
Mississippi
ABSTRACT
• One of the most important policy changes
has been the adoption of inflation
targeting. This paper explores inflation
targeting in Asian nations. To this end we
calculate the presumed inflation target in
Indonesia, Japan, South Korea, Thailand,
and Taiwan by utilizing the Taylor rule.
Inflation targeting as an overall monetary policy comprises
five factors (Mishkin & Miguel 2001).
• First, a commitment to announce publicly what the medium-term
target rates is for inflation by the central banking authorities.
• Second, an institutional commitment made by the central authorities
to price stability as the overarching goal of monetary policy.
• Third, extensive analysis and information gathering is essential to
ensure that a variety of measures are available for decision makers
to formulate policy.
• Fourth, transparency in the political and financial systems,
particularly in the central bank, is essential for inflation targeting to
be successful.
• Fifth, the central bank and its directing body must be held
accountable for the bank’s actions.
Taylor Rule
• The Taylor rule is a monetary policy
rule. This type of rule models the
processes whereby a central bank makes
adjustments to interest rates based upon
existing economic reality. “The rules are
responsive, calling for changes in the
money supply, the monetary base, or the
short-term interest rate in response to
changes of the price level or real income”
(Taylor 1993).
The Taylor Rule
John Taylor presents a monetary policy rule that he characterizes as
one, “that captures the spirit of the recent research and which is
quite straightforward” (Taylor 1993). Thus we find the following
formulation and coefficients.
r=p+.5y + .5(p-2) + 2
where
r= the federal funds rate,
p= the rate of inflation over the previous four quarters
y= the percent deviation of real GDP from a target.
That is,
y= 100(Y-Y*)/Y* where
Y= real GDP, and
Y*= is the trend real GDP
THE MODEL
it = α + ρit-1 + β πt +γ Yt +ε
Where
it
πt
Yt
is the nominal interest rate
is the inflation rate in time t
is the output gap
Results
• The results for each country are presented
separately. South Korea declared inflation
targeting as its monetary policy in 1998. In the
year 2000 Thailand did the same. Although
Indonesia announced inflation targeting in 2005,
there is not enough data to study the impact of
the policy decision. Japan and Taiwan also
pursue inflation targeting, but so far we have not
been able to determine the actual date the policy
became effective. The t-values are in
parentheses under corresponding coefficients.
INDONESIA
The estimated equation for Indonesia is:
it = -.004 inflation – 1.95 output gap +.96 it-1
(.85)
(.56)
(47.94)
The adjustment coefficient is very close to one indicating rapid
adjustment for interest rates. This value is close to estimates
obtained by others however, it is on the high end (Clarida, Gali &
Gertler 1997). The coefficients for inflation and output gap are not
significant so one cannot put too much stock in their signs. For all
practical purpose they are zero, indicating that inflation targeting or
output targeting are not the primary policy objectives of the Central
Bank of Indonesia. On the other hand, the bank resorts to shock
therapy; it adjusts interest rates very rapidly. Almost in one period,
which is a month for this study, the interest rate reaches to its
targeted rate. The adjusted R-squared is 94%
JAPAN
The estimated equation for Japan is:
it = -.005 inflation + .29 output gap +.97 it-1
(0.67)
(0.97)
(150.4)
The adjusted R-Squared for Japan is 99%, the highest
among the countries under review. It also has the largest
coefficient for interest rate adjustment mechanism,
indicating the fastest correction among these countries.
However, since the coefficients for inflation or output gap
are not significant the policy objective of the central bank
of Japan cannot be determined. The overnight rate for
Japan has been close to zero for several years, which
might have contributed to lack of significance of the
variables.
SOUTH KOREA
The estimated equation for South Korea is:
it = -.01 inflation + 4.73 output gap +.96 it-1
(1.02)
(2.42)
(31.87)
The adjusted R-Squared is 95%. For South Korea too,
adjustments in interest rates are rapid. Although the
inflation coefficient is not significant the coefficient for
output gap is highly significant indicating output targeting
in South Korea for the study period.
TAIWAN
The estimated equation for Taiwan is:
it = -.009 inflation + 1.05 output gap +.92 it-1
(1.75)
(0.7)
(33.22)
The adjusted R-Squared is 86%. Although the
adjustment factor is lower than that of Indonesia
it is fairly high. Furthermore, the coefficient for
inflation is significant at the 8%, therefore there
is some evidence of inflation targeting.
THAILAND
The estimated equation for Thailand is:
it = -.007 inflation + 1.94 output gap +.94 it-1
(0.677)
(0.85)
(32.06)
The adjusted R-Squared is 84%. However, the only
significant variable is the lagged interest rate, which also
has a high value indicating fairly rapid implementation of
changes in interest rates. Since the other coefficients are
not significant no inference can be made about the policy
target of the central bank.
CONCLUSIONS
The results for the reaction functions of these far-east Asian
countries are similar. They all have very high adjusted R-Squares, in
part due to inclusion of the lagged interest rate. All have fairly high
adjustment coefficients indicating that the changes in interest rate
are implemented very quickly. Since the periodicity of the data is
monthly the central banks of these nations adjust to their desired
rate of interest within a month at the rate of Indonesia 96%, Japan
97%, South Korea 96%, Taiwan 92%, and Thailand 94%. These are
much higher than the adjustment rates reported for new entrants to
the European Union and close to the estimate for Japan (MariaDolores 2005; Clarida, Gali & Gertler 1997). In several cases it is not
possible to determine if the respective central banks of these
countries are pursing an inflation targeting or an output targeting
policy. The clear exceptions are Taiwan (inflation targeting) and
South Korea (output targeting).