Many studies have tested the Taylor rule for monetary policy conduct internationally. However, there have been few studies carried out for emerging markets. Studies undertaken by Petersen (2007), Castro (2008) and Cukierman (2004) mainly focus on nonlinear models in developed economies such as the US and UK. Notably, there is a gap within emerging markets in particular South Africa that presents an opportunity for theutilization of nonlinear models to characterize the behaviour of the Reserve Bank using interest rate functions. Interest rate reaction functions have normally been formulated using the linear Taylor rule. This could be attributed to the notion that linear models on several cases are perceived to render reasonable approximations to the exact nonlinear interactions.

The Taylor rule spells out that the interest rate adjusts in accordance to the deviation of inflation from its target and real output from potential output. It also assumes in the US for instance, the federal funds rate is raised by 1.5 percentage points for each 1 percentage point increase in inflation (Taylor 1993). Further, an increase in the interest rate of that magnitude would raise real interest rates and help cool off the economy, thus reducing inflationary pressures. According to Taylor (1993), the rule also assumes that interest rates are reduced by 0.5 percentage point for each percentage point decline in real GDP below its potential. Such a reduction in the interest rate helps to mitigate a (growth cycle) recession and maintain price stability.