Monetary Transmission in three Central European Economies: Evidence from Time-Varying Coefficient Vector Autoregressions

This paper studies the transmission of monetary policy to macroeconomic variables in three new EU Member States in comparison with that in the euro area with structural time-varying coefficient vector autoregressions. In line with the Lucas Critique reduced-form models like standard VARs are not invariant to changes in policy regimes. The countries we study have experienced changes in monetary policy regimes and went through substantial structural changes, which call for the use of a time-varying parameter analysis. Our results indicate that in the euro area the impact on output of a monetary shock have decreased in time while in the new member states of the EU both decreases and increases can be observed. At the last observation of our sample, the second quarter of 2008, monetary policy was the most powerful in Poland and comparable in strength to that in the euro area, the least powerful responses were observed in Hungary while the Czech Republic lied in between. We explain these results by the credibility of monetary policy, openness and the share of foreign currency loans.