The development of causal linkages between monetary instruments and monetary targets in central Europe: The case of Poland and Hungary

This dissertation examines the development of causal linkages between monetary instruments (interest rates), intermediate monetary targets (money supply growth), and monetary targets (inflation rates) in Poland and Hungary by employing time-series analysis for the period of 1988-1995. The study applies a unit root test for a series with a change in the mean recently developed by Perron (1990), a linear time trend test, and vector autoregression models with Granger-causality and multiplier effect tests on the money growth rate, the growth rate of consumer price indices, and interest rates to determine whether any systematic relationship exists between monetary instruments and monetary targets during the transition period in Poland and Hungary.;The results reveal that, for Polish data, only interest rates measured by the refinancing rate possess a unit root while other variables do not. The results for Hungarian data show a unit root for most variables, except the monthly growth rate of consumer prices, the monthly growth rate of producer prices, and market interest rates of fixed deposits with maturity less than one month. For Poland, the results also exhibit evidence of causality between interest rates and inflation rates with a negative multiplier effect, interest rates and money growth rates with no multiplier effect, and money growth rates and inflation rates with a positive multiplier effect. There also exists some feedback among them. The causality between interest rates and inflation rates also exists in the case of Hungary, however, the evidence is very weak. There also exists weak evidence of the feedback relationship from inflation rates to interest rates with a positive multiplier effect. There exists no multiplier effect of interest rates on inflation rates in the case of Hungary.;In conclusion, the findings reveal that Poland's interest rate instruments are more developed and do influence monetary targets vis-a-vis Hungary's. Further, the analysis suggests a sufficiently developed financial market in Poland to support monetary policies directing the economic transition, whereas, the opposite is true in Hungary.