Monetary Response to Oil Price Shock in Asian Oil Importing Countries: Evaluation of Inflation Targeting Framework

Oil price shock can have serious inflation consequences and, therefore, elicit timely response from the Central Banks (CB). Our paper analyses the monetary policy response to oil prices in 5 Asian EMDEs during 2008–2019. Not only these countries are heavily dependent on oil imports for their increasing demand for oil, but also the CBs of these countries have gradually adopted inflation targeting (IT) framework of monetary policy. Therefore, it is also imperative to examine the weightage the CBs assign to oil price shock, while operating in IT-framework as against in non-IT-framework. This forms the second important objective of our paper. We estimate the CBs’ decision on interest rates as response to Brent crude oil price using augmented Taylor rule, in a macro panel data framework. We employ estimators that allows for heterogeneity across countries and are robust to cross sectional dependence. Oil importing Asian countries face a negative supply shock, due to trade linkages, that exerts a greater impact on inflation. Consequently, our finding that CBs raised interest rates to prevent subsequent negative demand effects in the long run, is intuitive. Interestingly, our results also reveal that CBs following IT-framework resorted to interest setting at a lower level as a response to oil price shock. This asserts the efficacy of the IT-framework in terms of absorbing oil shocks.