Transparency and Credibility of Monetary Policy in Transition Countries: The Case of the Czech Republic

This is a study of what asset price can tell us about the evolving credibility of the monetary policy of the Czech National Bank (CNB). From the beginning of the 1990s, several market economies adopted direct inflation targeting (DIT). The focus of our analysis is to examine the effect of changes in the two-week repo rate (the official interest rate) on short and long–maturity market interest rates. Argument relies on information asymmetry and the existence of a stationary stochastic equilibrium with full knowledge of authorities reaction function. Only then will reaction be insignificant. Our research found at short maturities, the coefficients for changes in the official repo rate are lower in the DIT period than in pre-crisis period. The results are significant at the 5%-level. This implies that the hypothesis of no increase in the transparency of monetary policy with the introduction of DIT can be rejected. We found that bond yields and interest rate swap rates of maturities of 5 years and more did not react significantly (at the 5%-level) to official interest rate decisions in the DIT period. This is consistent with the hypothesis that monetary policy was credible both before and after introduction of DIT.