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ECB Reaction Functions and the Crisis of 2008

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  • Stefan Gerlach

    (Central Bank of Ireland and CEPR)

  • John Lewis

    (Economics and Research Division, De Nederlandsche Bank)

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    Abstract

    We estimate a reaction function for the European Central Bank (ECB) using forecasts of economic growth and inflation as regressors. We detect a shift after Lehman Brothers failed in September 2008 when the pre-crisis reaction function indicates that the zero lower bound may become a constraint. We detect a shift back in the second half of 2010, several months prior to the April 2011 rate increase. The interest rate cuts in 2008 were more aggressive than forecast by the pre-crisis reaction function. These findings are compatible with the literature on optimal monetary policy in the presence of a zero lower bound.

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    Bibliographic Info

    Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

    Volume (Year): 10 (2014)
    Issue (Month): 1 (March)
    Pages: 137-158

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    Handle: RePEc:ijc:ijcjou:y:2014:q:1:a:4

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    1. Roberto M. Billi, 2005. "The Optimal Inflation Buffer with a Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 2005 25, Society for Computational Economics.
    2. Gerlach, Stefan & Lewis, John, 2010. "The Zero Lower Bound, ECB Interest Rate Policy and the Financial Crisis," CEPR Discussion Papers 7933, C.E.P.R. Discussion Papers.
    3. Stephan Sauer & Jan-Egbert Sturm, 2007. "Using Taylor Rules to Understand European Central Bank Monetary Policy," German Economic Review, Verein für Socialpolitik, vol. 8, pages 375-398, 08.
    4. John C. Williams, 2009. "Heeding Daedalus: Optimal Inflation and the Zero Lower Bound," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(2 (Fall)), pages 1-49.
    5. Athanasios Orphanides & Simon van Norden, 1999. "The reliability of output gap estimates in real time," Finance and Economics Discussion Series 1999-38, Board of Governors of the Federal Reserve System (U.S.).
    6. Klaus Adam & Roberto M. Billi, 2005. "Optimal monetary policy under commitment with a zero bound on nominal interest rates," Research Working Paper RWP 05-07, Federal Reserve Bank of Kansas City.
    7. Gerlach-Kristen, Petra, 2003. "Interest rate reaction functions and the Taylor rule in the euro area," Working Paper Series 0258, European Central Bank.
    8. Dieter Gerdesmeier & Barbara Roffia, 2004. "Empirical Estimates of Reaction Functions for the Euro Area," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 140(I), pages 37-66, March.
    9. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
    10. Carl Walsh, 2003. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 93(1), pages 265-278, March.
    11. Chow, Gregory C & Lin, An-loh, 1971. "Best Linear Unbiased Interpolation, Distribution, and Extrapolation of Time Series by Related Series," The Review of Economics and Statistics, MIT Press, vol. 53(4), pages 372-75, November.
    12. Stefan Gerlach, 2007. "Interest Rate Setting by the ECB, 1999-2006: Words and Deeds," International Journal of Central Banking, International Journal of Central Banking, vol. 3(3), pages 1-46, September.
    13. Paolo Surico, 2003. "Asymmetric Reaction Functions for the Euro Area," Oxford Review of Economic Policy, Oxford University Press, vol. 19(1), pages 44-57.
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