This paper estimates forward-looking monetary policy reaction functions for the central banks in Japan, Germany, the UK, France, and Italy using a time-varying parameter model. Since the error term in a forward-looking monetary policy reaction function is correlated with the regressors, the conventional Kalman filter in a time-varying parameter model would result in invalid inferences. We utilize the framework developed by Kim (2006) and Kim and Nelson (2006) to deal with this issue of endogeneity in a time-varying parameter model. The empirical framework adopted in this paper also allows us to handle the issue of non-linearity that arises due to the interest rate smoothing and the issue of heteroscedasticity as pointed out by Sims (2001) and Sims and Zha (2002).The results show that the Bank of Japan had an aggressive anti-inflationary stance prior to 1991, but the response to expected changes in inflation dropped significantly after 1991. Not much evidence of time-variation is found in the Bundesbank's response to inflation, though the coefficient on inflation term was consistently greater than one. The German monetary policy played a significant role in the formulation of the E3 (UK, France, and Italy) monetary policy until 1991. The results also suggest that the Bank of England's response to Inflation increased after 1979 and this shift in the focus of the monetary policy coincided with the election of Margaret Thatcher as the Prime Minister of Britain.

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