Nonlinearities in Central Bank of Tunisia’s Reaction Function: Pre-and Post Revolution Analysis

Abstract

This paper seeks to check the existence of possible nonlinearity in the behavior of the Central Bank of Tunisia (CBT) in response to changes in macroeconomic variables over 2000:1-2018:12 period (pre-and post-2011 revolution). We used a general model with asymmetric loss function, which enables Central Bankers to weight differently positive and negative deviations of inflation and output from their reference values, as well as a nonlinear economic structure. The empirical analysis reveals that in the pre-revolutionary period, the CBT, for the sake of financial stability approved asymmetric preferences only toward the inflation rate in the sense that it reduces interest rate by a larger amount when inflation is expected to be below the target than the amount it will increase it when it is expected to be above target. During the post-revolutionary period, which was marked by a severe economic recession, the CBT also showed asymmetric preferences toward the output stabilization as it reacted more vigorously to recession. Nevertheless, for a sufficiently large inflation pressure strengthened by the nonlinear economic structure, the CBT is obliged to enhance sharply the political instrument and to carry out a strict restrictive monetary policy.

KEYWORDS:

• Monetary policy
• asymmetric preferences
• nonlinear interest rate rules
• nonlinear phillips curve
• Tunisia

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 Linex: Linear-exponential loss function.

2 The “Linex” (Linear- exponential) specification was suggested by Varian (1974) and Zellner (1986) in Bayesian econometric analysis and integrated later by Nobay and Peel (1998) in the context of optimal monetary policy.

3 See Kobbi (2016) for more details.

4 For the baseline case, we used the HP filtered output but we conducted two other measures based on the output growth and moving average detrended output in the robustness analysis.

5 Given the convexity of the Phillips curve, any expansionary policy measures to boost economic activity is counterproductive and feeds inflation more. This evidence explains the inability of the CBT to alleviate the deep recession but on the contrary it has reinforced the inflationary tensions.

Additional information

Notes on contributors

Imen Kobbi

Imen Kobbi is an assistant professor at the Faculty of Economics and Management of Sfax, Tunisia.

Foued badr Gabsi

Foued badr Gabsi is a professor at the Faculty of Economics and Management of Sfax, Tunisia.