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Lessons from the Crisis. Did Central Banks Do Their Homework?

The outbreak of the global financial crisis triggered changes in thinking about the way monetary policy is conducted, in particular about the desired central banksâ€™ reaction function. However, a change in thinking does not necessarily mean that central banks really implemented these modifications. Therefore, I investigate whether four selected European central banks in small open economies â€“ E‡CeskÂ´a NÂ´arodnÂ´A± Banka, Magyar Nemzeti Bank, Narodowy Bank Polski and Sveriges Riksbank, have adjusted their reaction function to the new paradigm of how monetary policy should be conducted. To address this problem I use a logit model to see first, how the relative importance of inflation and GDP forecasts in the process of setting interest rates evolved over time, second, how the forecast horizon which central banks take into consideration when setting the interest rate has changed, and finally whether they conduct more accommodative monetary policy. The outcomes indicate that all banks after the Lehman Brotherâ€™s collapse became more flexible in the way they conduct monetary policy. In order to maintain the stability of the whole economy they are ready to accept an extended period or greater deviations of inflation from the target, although each one in its own way â€“ through extension of the forecasting horizon, the increase of the GDPâ€™s importance, permanent shift of the monetary policy stance to more accommodative one or a mixture of these factors.