Bangladesh Bank Training Academy Journal

Abstract

Monetary policy maker adjusts its policy instruments to reach the policy objectives under the guideline of a monetary policy rule. In this context, monetary policy rule could be better described by monetary policy reaction function.The purpose of this study is to examine Bangladesh Bank's monetary policy reaction function applying VAR model over the period of 2004m1 to 2017m11. The results show that the call money rate has positive and significant response to a shock to the inflation gap, the exchange rate gap or the lagged call money rate, while it responds negatively to a shock of output gap. Similar results have been found when we re-estimate the model using Treasury bill rate. These outcomes suggests that we can apply and extend the Taylor rule using inflation gap, output gap, exchange rate and lagged interest rate in case of Bangladesh. The study has also an important policy implication of choosing the treasury bill rate as the policy instrument in implementing the monetary policy