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Interest rate reaction functions and the Taylor rule in the Euro area

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Author Info
Petra Gerlach-Kristen () (WWZ, University of Basel, Petersgraben 51, CH-4003 Basel, Switzerland.)
Abstract

Traditional Taylor rules, which are estimated using a level specification linking the short-term interest rate to inflation and the output gap, are unstable when estimated on euro area data and forecast poorly out of sample. We present an alternative reaction function which takes the non-stationarity of the data into account. The estimated interest rate rule is stable and forecasts well. In contrast to the traditional Taylor rule, we find a significant role for the long rate, which we argue reflects shifts in the public's perception of the long-run inflation objective. JEL Classification: C22; E52.

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Paper provided by European Central Bank in its series Working Paper Series with number 258.

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Length: 39 pages
Date of creation: Sep 2003
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Handle: RePEc:ecb:ecbwps:20030258

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Keywords: ECB Taylor rule cointegration.

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Kozicki, Sharon & Tinsley, P. A., 2001. "Term structure views of monetary policy under alternative models of agent expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 25(1-2), pages 149-184, January. [Downloadable!] (restricted)
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  3. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July. [Downloadable!] (restricted)
    Other versions:
  4. Claus Brand & Nuno Cassola, 2000. "A money demand system for Euro area M3," Working Paper Series 39, European Central Bank. [Downloadable!]
  5. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39, pages 195-214, December. [Downloadable!] (restricted)
  6. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1, pages 19-46. [Downloadable!] (restricted)
  7. Kozicki, Sharon & Tinsley, P. A., 2001. "Shifting endpoints in the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 613-652, June. [Downloadable!] (restricted)
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  8. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September. [Downloadable!] (restricted)
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  9. Hardouvelis, Gikas A., 1994. "The term structure spread and future changes in long and short rates in the G7 countries: Is there a puzzle?," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 255-283, April. [Downloadable!] (restricted)
  10. Barbara Roffia & Dieter Gerdesmeier, 2003. "A comprehensive model on the Euro overnight rate," Working Paper Series 206, European Central Bank. [Downloadable!]
  11. Gabriel Fagan & Jérôme Henry & Ricardo Mestre, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series 42, European Central Bank. [Downloadable!]
  12. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June. [Downloadable!] (restricted)
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  13. Günter Coenen & Volker Wieland, 2000. "A small estimated Euro area model with rational expectations and nominal rigidities," Working Paper Series 30, European Central Bank. [Downloadable!]
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  14. Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 47-64. [Downloadable!]
  15. Gerlach, Stefan & Schnabel, Gert, 2000. "The Taylor rule and interest rates in the EMU area," Economics Letters, Elsevier, vol. 67(2), pages 165-171, May. [Downloadable!] (restricted)
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  16. Jon Faust & John H. Rogers & Jonathan H. Wright, 2001. "An empirical comparison of Bundesbank and ECB monetary policy rules," International Finance Discussion Papers 705, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Petra Gerlach-Kristen, 2004. "Interest-Rate Smoothing: Monetary Policy Inertia or Unobserved Variables?," Contributions to Macroeconomics, Berkeley Electronic Press, vol. 4(1), pages 1169-1169. [Downloadable!] (restricted)
  2. Janko Gorter & Jan Jacobs & Jakob de Haan, 2007. "Taylor Rules for the ECB using Consensus Data," DNB Working Papers 160, Netherlands Central Bank, Research Department. [Downloadable!]
  3. Maria Eleftheriou & Dieter Gerdesmeier & Barbara Roffia, 2006. "Monetary policy rules in the pre-EMU era - Is there a common rule?," Working Paper Series 659, European Central Bank. [Downloadable!]
  4. Alexander Mihailov, 2007. "Does Instrument Independence Matter under the Constrained Discretionof an Inflation Targeting Goal? Lessons from UK Taylor Rule Empirics," Money Macro and Finance (MMF) Research Group Conference 2006 95, Money Macro and Finance Research Group. [Downloadable!]
  5. Paul Mizen & Tae-Hwan Kim & Alan Thanaset, 2007. "Evaluating the Taylor Principle Over the Distribution of the Interest Rate: Evidence from the US, UK and Japan," Money Macro and Finance (MMF) Research Group Conference 2006 51, Money Macro and Finance Research Group. [Downloadable!]
  6. Michael Lamla & Sarah M. Rupprecht, 2006. "The Impact of ECB Communication on Financial Market Expectations," Working papers 06-135, KOF Swiss Economic Institute, ETH Zurich. [Downloadable!]
  7. Karsten Ruth, 2007. "Interest rate reaction functions for the euro area," Empirical Economics, Springer, vol. 33(3), pages 541-569, November. [Downloadable!] (restricted)
  8. Ansgar Belke & Thorsten Polleit, 2006. "How the ECB and the US Fed Set Interest Rates," Diskussionspapiere aus dem Institut für Volkswirtschaftslehre der Universität Hohenheim 269/2006, Department of Economics, University of Hohenheim, Germany. [Downloadable!]
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  9. Alexander Mihailov, 2005. "Has More Independence Affected Bank of England's Reaction Function under Inflation Targeting? Lessons from Taylor Rule Empirics," Economics Discussion Papers 601, University of Essex, Department of Economics. [Downloadable!]
  10. Heather Anderson & Mardi Dungey & Denise Osborn & Farshid Vahid, 2007. "Constructing Historical Euro Area Data," Money Macro and Finance (MMF) Research Group Conference 2006 99, Money Macro and Finance Research Group. [Downloadable!]
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  11. Ruth, Karsten, 2004. "Interest rate reaction functions for the euro area Evidence from panel data analysis," Discussion Paper Series 1: Economic Studies 2004,33, Deutsche Bundesbank, Research Centre. [Downloadable!]
  12. Gerberding, Christina & Seitz, Franz & Worms, Andreas, 2007. "Money-based interest rate rules: lessons from German data," Discussion Paper Series 1: Economic Studies 2007,06, Deutsche Bundesbank, Research Centre. [Downloadable!]
  13. Kai Carstensen & Roberta Colavecchio, 2004. "Did the Revision of the ECB Monetary Policy Strategy Affect the Reaction Function?," Kiel Working Papers 1221, Kiel Institute for the World Economy. [Downloadable!]
  14. Stephan Sauer & Jan-Egbert Sturm, 2003. "Using Taylor Rules to Understand ECB Monetary Policy," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
  15. Linda S. Goldberg & Michael W. Klein, 2005. "Establishing Credibility: Evolving Perceptions of the European Central Bank," The Institute for International Integration Studies Discussion Paper Series iiisdp105, IIIS. [Downloadable!]
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  16. P. Siklos & M. Bohl, 2006. "Asset Prices as Indicators of Euro Area Monetary Policy: An Empirical Assessment of Their Role in a Taylor Rule," Working Papers eg0053, Wilfrid Laurier University, Department of Economics, revised 2006. [Downloadable!]
    Other versions:
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