An Empirical Analysis of the Monetary Policy Reaction Function

Abstract

Monetary policy decisions usually follow a policy rule which shows a consistent response of policy instruments to variations in inflation and economic growth. The aim of this study is to establish the nature of monetary policy in developing countries through the analysis of policy reaction functions. This study uses macroeconomic data from Ghana, a typical developing country. The study employs the Dynamic Ordinary Least Squares Estimation techniques and finds the central bank to follow a backward-looking Taylor rule. The evidence is that the central bank follows some form of policy rule and focuses more on past inflation relative to current or expected inflation. The results also indicate that the Bank of Ghana has been pursuing inflation targeting monetary policy. The central bank follows an inflation targeting rule allowing for output stabilisation. The exchange rate also plays a role in this stabilization effort.