Monetary Policy Efficiency and the Taylor Curve: Evidence from Hungary

This chapter explores the intricate relationship between inflation and the output gap, focusing on the efficiency of monetary policy in Hungary. By employing the Taylor Curve theory, it assesses the trade-off between the variances of these two critical economic variables, providing a measure of monetary policy's ability to maintain economic stability. The study introduces a dynamic approach using a Time-Varying Parameter (TVP) model, which allows for a more accurate representation of real-world conditions and captures the evolving nature of the Taylor Curve over time. This dynamic perspective is particularly valuable in understanding how monetary policy efficiency responds to economic events such as financial crises, pandemics, and geopolitical developments. The chapter also makes a methodological contribution by relaxing the deterministic assumption in variance equations, using a stochastic volatility (SV) model to estimate conditional volatilities more accurately. This approach enhances the robustness and accuracy of the dynamic assessment, offering a clearer picture of the challenges faced by Hungarian monetary policy. The analysis identifies periods of suboptimal monetary policy, aligning with historical events and policy decisions, and provides insights into the current state of monetary policy efficiency in Hungary. By offering a dynamic perspective on the Taylor Curve, this research contributes to the ongoing discourse on optimal monetary policy, especially in transitional economies facing external shocks and unconventional policy measures.