Taylor rule and the conduct of monetary policy in Tunisia

Following the failure of monetary targeting theory in the eighties, several authors have proposed alternatives. The Taylor rule is commonly accepted in recent years for the determination of interest rates in order to achieve the final goal of the central bank. The present study tends to lead an analysis of the compatibility of behavior of central bank of Tunisia (CBT) in the monetary policy conduct with the Taylor rule. The results obtained from quarterly data ranging from 1997 to 2011 showed that the original Taylor rule has a low explicative power of the monetary authorities' behavior in Tunisia. The proposed forward-looking rule describes plausibly interest rates dynamics. In this rule, the money market rate (MMR) is dependent on its past level, the output gap between current and potential output, the deviation of expected inflation from the implicit target, the differential of money market rate between Tunisia and the euro area and the inflation differential between Tunisia and France. Therefore, the Tunisian monetary policy can follow a rule based on two main aggregates taken as targets, whose names are inflation and economic growth. The reaction function can be considered as a proposal for a new reform of the monetary policy of the Central Bank.