Abstract:

This paper estimates the monetary policy reaction function for two sets of MENA countries: The inflation target countries, (Turkey and Israel) and the exchange rate target countries, (Jordan and Morocco). We motivate our empirical analysis by analyzing a simple Taylor rule. This model looks at the effects of inflation and output on setting the interest rate by the central bank. Furthermore, we extended our model by adding the exchange rate and the foreign interest rate using similar model used by Clarida et al (1998) with using GMM estimator. Findings of this study yield some interesting results, all the central banks in the sample uses interest rate smoothing in managing their monetary policy. In addition, The Central bank in Turkey, Israel and Morocco focuses on achieving low level of inflation. On the other hand, the Monetary Authority in Jordan cares about stabilizing the output gap. Estimating the extended Taylor rule suggests the highly significant effect of foreign interest rate on setting the interest rate in Turkey. Taken all together, the results lend support to the importance of following a rule rather than discretionary in reducing the inflation rate and credible monetary policy. In addition, the simple Taylor rule can be applied on MENA countries but it requires some modification such as adding the exchange rate and the foreign interest rate.

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