Central bank behavior, the institutional framework, and policy regimes: Inflation versus noninflation targeting countries

This article estimates central bank reaction functions for 20 OECD countries. It bridges the gap between the Taylor reaction function literature and the political-economy literature. Central banks react to both inflation and the output gap. Moreover, inflation-targeting countries have been able to reduce nominal interest rate to a greater extent than have non-inflation-targeting countries. Countries with fixed exchange rates react more strongly to inflation but not at all to the output gap, unlike countries with floating rates. Political influences also seem relatively more important in fixed exchange rate countries. Central bank independence also helps reduce nominal interest rates.