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Political business cycles and monetary policy revisited–an application of a two-dimensional asymmetric Taylor reaction function


This paper uses two-dimensional asymmetric Taylor reaction functions for 16 OECD-countries to account for different reactions to the inflation rate and output by central banks before or after an election of the fiscal authorities in the respective country. Important for such an investigation is not only the period before or after an election takes place but also whether the inflation rate and output are below or above their target or potential value because this information shows whether the central bank systematically deviates from the Taylor rule. Using a Panel-GMM we observe that in the OECD-countries there are political business cycles in monetary policy with respect to the inflation and output response. However, the supporting time horizon differs between both exogenous indicators and state of variables.

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  1. To build an aggregate measure of central bank independence a point score is introduced which captures different dimensions of independence as e.g. who appoints the members of the board of the central bank, the budgetary role of central banks or the objective of the central bank (see Bade and Parkin 1988; Grilli et al. 1991 or Eijffinger and Schaling 1995 among others).

  2. Belke and Potrafke (2009) give an excellent overview over the studies in this field so far.

  3. These countries are: Chile, Czech Republic, Finland, Greece, Hungary, Iceland, Ireland, Israel, Luxembourg, Mexico, New Zealand, Poland, Portugal, Slovenia, Slovak Republic, South Korea and Turkey.

  4. Within the recent financial crisis it was observed that interest rate cuts or implementation of “unconventional” policy measures were executed at even higher than monthly frequencies.

  5. The assumption of a constant inflation target is challenged by Leigh (2008). There are also several studies estimating a time varying equilibrium real interest rate (see e.g. Laubach and Williams 2003; Cuaresma et al. 2004; Clark and Kozicki 2005; Arestis and Chortareas 2007; Mésonnier and Renne 2007 or Garnier and Wilhelmsen 2009). Belke and Klose (2010) investigate this issue in a Taylor rule framework.

  6. Such an approach is also used by Bec et al. (2002) or Bunzel and Enders (2010) to estimate asymmetric Taylor reaction functions if inflation and output are above or below some target value. Klose (2011) merges both studies and shows that there are asymmetries in the ECB reaction depending on a combination of inflation and output asymmetries.

  7. The number of observations can differ if the election day is at the beginning or end of the sample period, so that there are not enough data points before or after. But these differences are in our context negligible.

  8. Note that six of the 16 countries in this sample have introduced inflation targeting in the last years. So they should only react to this measure. However, tackling the output gap is also reasonable for these countries since the output gap is a good indicator of future inflationary pressures that these central banks need to account for besides the current inflation rate.

  9. Since the US-Dollar and US-Dollar exchange rate is constant we use year-on-year money growth for the US instead of an exchange rate.

  10. These countries are: Austria, Belgium, France, Germany, Italy, Netherlands, Spain.

  11. In January 2011 Estonia became the seventeenth member of the euro area.


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Correspondence to Jens Klose.

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The views expressed in this paper are my personal views and do not necessarily coincide with those of the German Council of Economic Experts.

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Klose, J. Political business cycles and monetary policy revisited–an application of a two-dimensional asymmetric Taylor reaction function. Int Econ Econ Policy 9, 265–295 (2012).

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  • Political business cycle
  • Monetary policy
  • Taylor rule
  • Asymmetries
  • Panel-GMM

JEL Classification

  • E32
  • E43
  • E52
  • E58