The conduct of monetary policy in the Eurozone before and after the financial crisis

The recent financial crisis of 2007–2009 raises several issues related to the conduct of monetary policy during the last two decades. Inflation targeting monetary strategy has been pointed as a potential source of the crisis, as its main objective of inflation stabilization might have diverted central banks from financial stability. We consider the case of European Central Bank (ECB) inflation targeting monetary policy since its inception in order to provide evidence of possible changes in its implementation after the collapse of Lehman Brothers in September 15, 2008. To this end we take into consideration the existence of nonlinearities that may be present in the estimated Taylor rule specification. We contribute to the recent line of research by estimating Taylor rule models with endogenous structural breaks as well as a Markov-Switching VAR model with endogenous coefficients using quarterly data for the ECB for the period 2001:Q1 to 2013:Q4. The main findings of our analysis show that there is a structural break in the implementation of the monetary policy of ECB during the peak of the financial crisis. Furthermore, we show that the ECB monetary policy followed the Taylor principle during the period before the crisis but did not follow the Taylor rule in the post-crisis period. During the post-crisis the ECB acted less inertially, putting a smaller weight on the inflation gap and shifted its focus on output gap to some extent.