Kirdan Lees

Do the Central Banks of Australia and New Zealand Behave Asymmetrically? Evidence from Monetary Policy Reaction Functions

We test for evidence of asymmetric behaviour in the monetary policy reaction functions of the central banks of Australia and New Zealand. For the Reserve Bank of New Zealand, we found little evidence of asymmetric behaviour, whereas the Reserve Bank of Australia (RBA) appears to react more aggressively to negative output relative to positive output gaps of the same size. We impose additional structure on our model to help distinguish whether the asymmetric response originates from non-linearity in the inflation equation or from non-linearity in an approximate representation of the RBAs preferences over macroeconomic outcomes. We find that the preferences of the RBA may drive the asymmetry: the RBA appears to dislike negative output gaps more than positive output gaps of the same magnitude. We show this generates only a small increase in the conditional mean of inflation that is statistically indistinguishable from the target rate of inflation.

How Costly is Exchange Rate Stabilisation for an Inflation Targeter? The Case of Australia

This paper quantifies the costs of mitigating exchange rate volatility within the context of a flexible inflation targeting central bank. Within a standard linear-quadratic formulation of inflation targeting, we append a term that penalises deviations in the exchange rate to the central banks loss function. For a simple forward-looking new-Keynesian model, we show that the central bank can reduce volatility in the exchange rate relatively costlessly by aggressively responding to the real exchange rate. However, when we append correlated shocks to better match summary statistics of the Australian data, we find that the costs associated with reducing exchange rate volatility are larger: output volatility increases substantially. Finally, we apply our method to a variant of a small backward-looking new-Keynesian model of the Australian economy. Under this model, large increases in inflation and output volatility accrue if the central bank attempts to mitigate exchange rate volatility.