Abstract:

This paper’ aim is twofold: Firstly, it aims to extend the traditional Taylor rule with the real exchange rate. Secondly, by using the NARDL model, it aims to provide empirical results that the effects of real exchange rate changes on interest rate is asymmetric in selected emerging markets of Brazil, Chile, Mexico, South Africa, South Korea and Turkey. The NARDL estimation results and dynamic multipliers indicate the presence of long-run asymmetric cointegration relationship between interest rate and the variables of the inflation gap, output gap and the real exchange rate. Especially, the empirical findings indicate that the real exchange rate has asymmetrical effects on interest rate for all selected countries, except Brazil. The estimation results suggest that the policy reaction functions in the selected emerging countries are not only responding to inflation gap and output gap, but also reacting asymmetrically to real exchange rate changes. Hence, these empirical results support that the augmented Taylor rule with exchange rate and asymmetric form is a better representation for monetary policy reaction of the selected emerging countries.

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