DO CENTRAL BANKS HAVE PRECAUTIONARY DEMANDS FOR EXPANSIONS AND FOR PRICE STABILITY? THEORY AND EVIDENCE

V. Anton MUSCATELLI (University of Glasgow, UK)
Alex CUKIERMAN (Tel Aviv University, Israel)

This paper analyses the impact of asymmetric prefernces with respect to inflation and output by policymakers on interest-rate reaction functions. A theoratical framework which makes it possible to identify the dominant type of asymmetry is developed and related to the precautionary demand of policymakers for expansions and for low inflation. Using data for for some G7 economies, the paper shows that, except for Germany, nonlinear and asymmetric behaviour is present. A main finding is that where credibility-building and disinflation has already been achieved, the monetary authorities develop a greater precautionary demand for output expansion than for low inflation. This may generate a new type of inflation bias. Conversely, where credibility-building is still a concern for the authorities, manging the business cycle is dominated by concerns of the monetary authorities to keep inflation expectations low.