Monetary Policy Rules in Emerging ASEAN Economies: Adaptability of Taylor Principle

Introduction

The monetary policy rules in emerging ASEAN economies have made great progresses since the 2000s. As a typical example, some of their economies, Indonesia, the Philippines, and Thailand, have adopted the inflation targeting (hereafter, IT) framework to control inflation, and have managed their policy interest rates for materializing the IT system. The major background of their IT adoption was that they experienced the Asian currency crisis in the late 1990s; the crisis made them switch their exchange rate regimes from a pegged one to a floating one, and there came the necessity to search for an alternative anchor for price stability instead of a pegged currency regime (see Mishkin, 2000, for instance). Another background was that emerging ASEAN economies had ever applied a monetary aggregate target before the 2000s; the monetary aggregate approach had lost its significance since the financial deregulation and innovation during the recent decades have weakened the linkage between monetary aggregate and inflation rate, thereby requiring an alternative framework for monetary policy target. Regarding the evaluations of the IT performances in emerging ASEAN economies, there have been rather less evidence due to their relatively shorter histories of its adoption and to some difficulties in its management, while the IT performances in advanced countries are widely appreciated (Mishkin & Posen, 1998; Mishkin & Schmidt-Hebbel, 2007).

One of the criteria for judging a monetary policy rule’s relevance is, in general, the adaptability of the “Taylor principle”: for inflation to be stable, the central bank must respond to an increase in inflation with an even greater increase in the nominal interest rate (Mankiw, 2016). The Taylor principle is considered to hold in the monetary policy rules in advanced economies such as the US and Japan (Clarida & Gertler, 1997; Clarida et al., 1998a; Clarida et al., 1998b; Belke and Polleit, 2007). For emerging market economies, however, there are relatively less evidence that their policy rules fulfil the Taylor principle, although the principle would be of vital importance particularly for the adopters of the IT framework.

Another point to be noted is that the monetary policy rules of emerging market economies have happened not to work well enough to control inflation, due to the “fear of floating” suggested by Calvo and Reinhart (2002). The monetary policy independence for controlling inflation is secured only under floating exchange rate with capital mobility according to the “impossible trinity” constraint. Emerging market economies are, however, afraid of their exchange rate fluctuations due to a lack of confidence in their currency values, and thus tend to face a trade-off between keeping their monetary autonomy and managing their exchange rate.

This paper aims to examine the monetary policy rules for emerging ASEAN economies: Indonesia, the Philippines and Thailand as the IT adopters, and Malaysia and Vietnam as the non-IT adopters. This study estimates monetary policy reaction functions by using the Generalized Method of Moments (GMM) on each sample economy. The major research questions in this study are twofold: whether the monetary policy rules of the IT adopters have fulfilled the Taylor principle for controlling inflation, and what has been the difference in monetary policy rules between the IT adopters and non-IT adopters, including the reaction to the fear of floating.

The rest of the paper is structured as follows: Section 2 introduces the monetary policy frameworks in five ASEAN sample economies; Section 3 reviews the literature and clarifies this study’s contributions; Section 4 conducts the GMM estimation of monetary policy rules; and the last section summarizes and concludes.