Taylor rules and interest rate dynamics in emerging market economies (Chile, Mexico, Korea, Poland, Czech Republic)

The main purpose of this research is to analyze short-term interest rate dynamics in five emerging market countries (Chile, Mexico, Korea, Poland and the Czech Republic) under inflation targeting. A model based on the Works of Ball (1999) and Taylor (2001) for open-economy Taylor rules was estimated to determine the factors driving the movement of the short-term interest set by monetary authorities of these countries. The results show that for most countries both inflation and output deviations from target levels are major determinants of the behavior of the short rate.; Another objective of this study was to extend the analysis of interest rate dynamics in the five countries to investigate possible asymmetric patterns in the behavior of the short-term interest rate. This investigation was conducted using Taylor rules and was based on nonlinear Smooth Transition Regression (STR) models. Three STR specifications were applied in analyzing interest rate dynamics. One model utilizes the logistic function; a model uses the quadratic logistic function and a three-regime model, which is based on the logistic function.; These findings reported in this study confirm many of the results reported by previous researchers applying linear Taylor rules to emerging market economies. However, the results obtained from the nonlinear dynamic analysis provide evidence that challenges the assumption of linearity underlying previous studies of these economies, and indicate that nonlinear Taylor rules provide a superior basis for evaluating inflation-targeting experience.