Monetary policy reaction functions in transition economies acceding to the EU

Altinger, Laura (2002) Monetary policy reaction functions in transition economies acceding to the EU. Doctoral thesis, University of London: London Business School.

Abstract

A number of Central European transition economies began transition from centrally-planned to market economies with sizeable budget deficits. Financing of the fiscal deficit was complicated by the initial inability of their underdeveloped tax systems to collect enough tax revenue, the fledgling state of financial markets in these countries that limited the sale of government securities and the general lack of international creditworthiness which prevented large-scale foreign borrowing. Consequently, it would appear that many transition countries had little alternative but to substantially monetise their deficits at the beginning of transition. As transition economies stabilised and become more integrated into the web of market economies, especially by the growing prospect of EU accession, one would expect transition economies to have experienced a switch in fiscal financing to more conventional methods used in advanced market economies. Therefore, one would expect the seigniorage effect to attenuate in the latter part of transition. This thesis examines this proposition by characterising the behaviour of five Central European transition economies, most likely to accede to the EU in the first round of accession, by means of the unifying framework of monetary feedback rules, specifically, Taylor rules. The estimated results show that monetary policy in the Czech Republic (from 1993) and in Estonia could be described by forward-looking inflation targeting. The other three countries experienced regime switches. The results for Hungary show that the seigniorage effect was important in the first half of the estimation period and then attenuated in the second half. Inflationary stabilisation was targeted by mimicking the Bundesbank's setting of its short-term policy instrument. Poland and Slovenia also experienced regime switches. For these countries, the first sub-period could not be characterised by inflation or output stabilisation. By contrast, during the latter half of the sample period, authorities pursued stabilisation with vigour. In Poland, this took the form of classic inflation and output stabilisation and the implicit interest rate smoothing. In Slovenia, it took the form of inflationary stabilisation, interest rate smoothing and guidance from the Bundesbank's setting of its short-term policy instrument.