Was the Interest Rate Policy of the ECB too Loose? Insight from a Simple Taylor Rule

The interest setting of a central bank can be explained using a rule-based monetary policy. A rulebased monetary policy framework considers major economic variables to make a recommended interest rate. In an economy, the fluctuations in major economic variables are vital indicators that signal an action from the central bank. In this paper, we scrutinize the short-term interest rate setting of the European Central Bank (ECB) based on the observed economic conditions. We have based our analysis on a simple Taylor rule. The investigation includes evidence and implication from a selected time period to reflect on the interest rate setting practice followed. For comparison purposes, the applicability and validity of a rule-based monetary policy are then analyzed for the US relying on the interest rate setting of the Federal Reserve. Our empirical findings confirm that the interest rate adjustments in the two central banks go along with the recommendations from a simple Taylor rule. Finally, taking the difference between the interest rate settings of the two banks, an empirical analysis is made to identify whether this difference can be attributed to the difference in simple Taylor rule recommendations.