Monetary policy in CEE countries: Is there a similar behavior of the monetary authorities?

This study investigates the conduct of the monetary policy in four major Central and Eastern European (CEE) countries: Czech Republic, Hungary, Poland and Romania. Although there are significant differences between these four economies, they underwent a similar process of integration with advanced Euro area economies during the period preceding the global economic downturn. This process mainly advanced in terms of financial integration, currently the financial and banking sectors of the region being dominated by Euro area entities, while lending in foreign currency is relatively high, reaching about two thirds of total private credit in the case of Romania. Starting from this empirical evidence, the present paper investigates the existence of a common pattern in the behavior of the four central banks. If such a pattern would be identified, it might be the result of similar constraints in terms of the monetary policy transmission.

Monetary policy is considered to be conducted following a Taylor rule with interest rate smoothing, the objective of the analysis being to answer the following specific questions: (i) How central banks in the region differ in terms of the relative importance awarded to price stabilization versus smoothing fluctuations in economic activity? (ii) How aggressive are monetary authorities in terms of obeying the Taylor principle? (iii) Was there a shift in the preferences of central bankers in the four CEE countries from stabilization of prices towards stimulating economic activity and safeguarding financial stability in the aftermath of global financial and economic crisis?

We provide comprehensive answers to these questions employing a wide range of econometric techniques including OLS and GMM classical regression techniques, OLS and 2SLS Bayesian methods, as well as time-varying and Markov Switching OLS estimations of the Taylor rule. Estimates were obtained based on ex post data series, but also on expectations series. The proxy variables for inflation expectations were consumer expectations quantitatively recovered in BCS poll but also the inflation expectations of analysts in the banking sector (where available).

The results suggest that there is a significant similarity in the behavior of the four CEE central banks in terms of monetary policy inertia, with the interest smoothing coefficient in the Taylor rule estimated for the National Bank of Romania being the smallest. Moreover, with the exception of the Czech National Bank (CNB), the responses to inflation of all the other monetary authorities are sufficiently aggressive and fulfill the Taylor principle, which suggests that of the four central banks under scrutiny, the CNB might be the least orthodox in applying the inflation targeting strategy.

The estimations that take into account the possibility of a regime switch in monetary policy behaviour in the four CEE countries succeeded in identifying two regimes, one corresponding to a “normal” development of the underlying economies, and the other one pertaining to the crisis period. The two regimes are distinguished both through different values of the coefficients and the volatility of monetary shocks, although, probably due to the low number of observations in the crisis regime, the results should be cautiously interpreted.