A TEST FOR ASYMMETRIC CENTRAL BANK PREFERENCES IN TURKEY
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Course
ASYMMETRIC
Institution
ASYMMETRIC
A TEST FOR ASYMMETRIC CENTRAL BANK PREFERENCES IN
TURKEY
Ertuğrul Üstün Geyik
Yıldız Technical University, Turkey
Abstract
The time inconsistency based KPBG models that tried to explain the inflation bias
lost their popularity as inconsistent Central Bank behaviors changed in time....
INTERNATIONAL JOURNAL OF SOCIAL SCIENCES AND HUMANITY STUDIES
Vol 3, No 2, 2011 ISSN: 1309-8063 (Online)
A TEST FOR ASYMMETRIC CENTRAL BANK PREFERENCES IN
TURKEY
Ertuğrul Üstün Geyik
Yıldız Technical University, Turkey
Abstract
The time inconsistency based KPBG models that tried to explain the inflation bias
lost their popularity as inconsistent Central Bank behaviors changed in time.
However, high inflation for countries like Turkey is still a problem and a new
theory to explain this ‘time consistent’ inflation bias is in need. A theory based on
non-linear or asymmetric Central Bank behavior is developed during the last
decade to fill this gap. One way to test the empirical validity of the theorem is
based on a Taylor Rule variant asymmetric model. This model is tested here for
Turkey as it is one of the inflation targeting countries roughly for the last ten
years.
Keywords: asymmetric preferences, inflation bias, policy targets, central bank
behavior.
JEL Classification : E50, E58, E61.
1. INTRODUCTION
The classical definition of inflation bias lost its ground during the last decade
though they have been referenced often during 1980’s and 1990’s. The loss of
popularity of these models have several reasons like increased transparency of
Central Banks, inflation target policies and governments that learned from their
past mistakes about monetary policies and increased Central Bank independence
may be counted for the decrease of inflation. Of course low inflation levels
brought critics to the inflation biased Central Bank models of Kydland Prescott-
Barro Gordon (KPBG) models with quadratic loss functions that ambitiously
target higher output levels.
These critics have theoretical, practical and empirical aspects. Theoretically
McCallum (1995, 1997) argues with the idea of persistent inflation biased
policies. Even if Central Bank created inflation while trying to increase output, the
diverse results of these policies are obvious and it is irrational to model Central
Bank as a persistent cheater. Though this critic is meaningful, it does not explain
179
, INTERNATIONAL JOURNAL OF SOCIAL SCIENCES AND HUMANITY STUDIES
Vol 3, No 2, 2011 ISSN: 1309-8063 (Online)
the inflation differences among different countries and different periods. More
than Central Bankers under this structure may be a limited delegation of public
without any power or preferences.
Practically the ex-vice chairman of FED Alan Blinder insisted that during his
period FED did not apply biased policies that led to time inconsistency. So
ambitious Central Banker can not be the main reason of high inflation. However
Blinder (1998) also claims that: “In most situations, the central bank will take far
more political heat when it tightens pre-emptively to avoid higher inflation than
when it eases pre-emptively to avoid higher unemployment”. Thus Central Banker
still has some headroom to reflect part of their preferences to the policies and
these preferences may be asymmetric.
Empirically, Ireland (1999) the seminal empirical paper of inflation bias did not
find evidence for the bias for the short term though there are evidences for the
long term.
All these changes and critics may be true. However, there is still an inflation
phenomenon that has to be explained via Central Bank decisions. Especially after
inflation targeting policies became popular among countries, some countries still
can not achieve their targets while others even surpass their targets and even
undershoot their targets. The ‘new inflation bias’ theory tries to explain these
differences and in some cases the persistent inflation even under there are binding
contracts for Central Bankers.
The asymmetric Central Banker in Cukierman (2000) tradition does not change
output or unemployment directly by active policies, but it gives different
responses to actual business cycles or exogenous supply shocks. As the output
growth increases above the natural level (say by 1 per cent) Central Banker shows
less effort to reduce the gap when compared to the output decrease from the
natural level at the same rate. Such an indirect policy may lead to an average
growth rate above the natural level or inflation bias, though Central Banker does
not directly intend to do it. So Cukierman (2000)’s central banker is
asymmetrically biased toward inflation.
Ruge-Murcia (2003) focuses another kind of inflation bias, which points out just
the opposite direction. Central Banker weights positive inflation deviations more
heavily than negative inflation deviations from the target inflation level, because
of the credibility considerations of the Central Banker. This means when inflation
level increases one per cent above the targeted inflation level, Central Banker
rapidly applies policies to turn it back to low inflation level, but when inflation
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