Global Factors Driving Inflation and Monetary Policy: A Global VAR Assessment
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Global Factors Driving Inflation and Monetary Policy: A Global VAR Assessment Martin Feldkircher1,2 · Gabriele Tondl3
Published online: 21 August 2020 © International Atlantic Economic Society 2020
Abstract This paper examines the nexus between inflation and central bank interest rate policies in inflation-targeting countries. First, it looks at the role of inflation among other factors affecting monetary policy. Second, it looks at the drivers of inflation alone. Thereby, the role of international spillovers from other countries is explicitly regarded as well, with the aim of assessing the extent to which inflation is driven by other countries’ inflation or monetary policy is influenced by other economies. The empirical study covers advanced countries and emerging market economies for the period 1995 - 2016 and uses Bayesian global vector autoregression to model external linkages and to account for variable uncertainty. This study finds that inflation plays an important role for monetary policy. More importantly, central banks clearly consider additional factors and notably other countries’ key indicators when setting interest rates. Inflation in turn is determined by both internal and external factors like the exchange rate and other countries’ inflation. These findings are much more comprehensive than previous literature and demonstrate that central banks consider a multitude of domestic and global factors. Keywords Monetary policy · Inflation · Global VAR JEL Classification E40 · E43 · E44 This paper was written while Gabriele Tondl was a visiting fellow at the Austrian National Bank. She also gratefully acknowledges funding under the Research Contract 2016 of the Anniversary Fund of the Vienna University of Economics and Business. The opinions expressed in this paper are those of the authors and do not necessarily reflect the official viewpoint of the Austrian National Bank or the Eurosystem. Gabriele Tondl
[email protected] 1
Oesterreichische Nationalbank (OeNB), Otto-Wagner-Platz 3, 1090 Vienna, Austria
2
Vienna School of International Studies (DA), Favoritenstraße 15a, 1040 Vienna, Austria
3
Department of Economics, Institute for International Economics, Vienna University of Economics and Business (WU), Welthandelsplatz 1, 1020 Vienna, Austria
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M. Feldkircher, G. Tondl
Introduction To what extent must central banks (CBs) consider global developments when formulating their monetary policies and are they actually watching external factors? In the decisions of CBs, inflation plays a prominent role. Many studies investigated how CBs react to shifts in inflation and how, in turn, CB monetary policy interest setting shapes inflation. Vector autoregression (VAR) modelling has become a common method to study this inflationmonetary policy nexus. However, those studies generally neglect the likelihood that guiding indicators and policy decisions of CBs may be subject to a number of global influences. Monetary authorities underlined recently that their guiding indicator, inflation, has become incr
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