Are Eastern European Taylor Reaction Functions Asymmetric in Inflation or Output? Empirical Evidence for Four Countries

Do central banks in Eastern European countries react asymmetrically and in a nonlinear fashion to changes in inflation and output? We address this question by expanding the standard Taylor reaction function for the four inflation-targeting countries Czech Republic, Hungary, Poland, and Romania. We do so by taking explicitly inflation rates below or above target and output below or above potential, the so-called state of the economy, into account. The results reveal that there are indeed substantial asymmetries in the reaction function of the Czech, Polish, and Romanian central banks, which are only evident when the combination of inflation and output thresholds is explicitly modeled in one estimation equation. For these three central banks, nonlinearities in the inflation and output response also could be verified.