Estimating monetary policy reaction functions : A discrete choice approach
AbstractI propose a discrete choice method for estimating monetary policy reaction functions based on research by Hu and Phillips (2004). This method distinguishes between determining the underlying desired rate which drives policy rate changes and actually implementing interest rate changes. The method is applied to ECB rate setting between 1999 and 2010 by estimating a forward-looking Taylor rule on a monthly basis using real-time data drawn from the Survey of Professional Forecasters. All parameters are estimated significantly and with the expected sign. Including the period of financial turmoil in the sample delivers a less aggressive policy rule as the ECB was constrained by the lower bound on nominal interest rates. The ECB's non-standard measures helped to circumvent that constraint on monetary policy, however. For the pre-turmoil sample, the discrete choice model's estimated desired policy rate is more aggressive and less gradual than least squares estimates of the same rule specification. This is explained by the fact that the discrete choice model takes account of the fact that central banks change interest rates by discrete amounts. An advantage of using discrete choice models is that probabilities are attached to the different outcomes of every interest rate setting meeting. These probabilities correlate fairly well with the probabilities derived from surveys among commercial bank economists.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by National Bank of Belgium in its series Working Paper Research with number 210.
Length: 40 pages
Date of creation: Feb 2011
Date of revision:
Contact details of provider:
Postal: Boulevard de Berlaimont 14, B-1000 Bruxelles
Phone: (+ 32) (0) 2 221 25 34
Fax: (+ 32) (0) 2 221 31 62
Web page: http://www.nbb.be
More information through EDIRC
monetary policy reaction functions; discrete choice models; interest rate setting; ECB;
Find related papers by JEL classification:
- C25 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-02-26 (All new papers)
- NEP-CBA-2011-02-26 (Central Banking)
- NEP-DCM-2011-02-26 (Discrete Choice Models)
- NEP-ECM-2011-02-26 (Econometrics)
- NEP-EEC-2011-02-26 (European Economics)
- NEP-MON-2011-02-26 (Monetary Economics)
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.:
- Hu, Ling & Phillips, Peter C. B., 2004.
"Nonstationary discrete choice,"
Journal of Econometrics,
Elsevier, vol. 120(1), pages 103-138, May.
- Gernot Doppelhofer & Ronald I. Miller & Xavier Sala-i-Martin, 2000.
"Determinants of Long-Term Growth: A Bayesian Averaging of Classical Estimates (Bace) Approach,"
OECD Economics Department Working Papers
266, OECD Publishing.
- Xavier Sala-I-Martin & Gernot Doppelhofer & Ronald I. Miller, 2004. "Determinants of Long-Term Growth: A Bayesian Averaging of Classical Estimates (BACE) Approach," American Economic Review, American Economic Association, vol. 94(4), pages 813-835, September.
- Gernot Doppelhofer & Ronald I. Miller & Xavier Sala-i-Martin, 2000. "Determinants of Long-Term Growth: A Bayesian Averaging of Classical Estimates (BACE) Approach," NBER Working Papers 7750, National Bureau of Economic Research, Inc.
- Jonathan H. Wright, 2009.
"Forecasting US inflation by Bayesian model averaging,"
Journal of Forecasting,
John Wiley & Sons, Ltd., vol. 28(2), pages 131-144.
- Jonathan H. Wright, 2003. "Forecasting U.S. inflation by Bayesian Model Averaging," International Finance Discussion Papers 780, Board of Governors of the Federal Reserve System (U.S.).
- Phillips, Peter C.B. & Jin, Sainan & Hu, Ling, 2007.
"Nonstationary discrete choice: A corrigendum and addendum,"
Journal of Econometrics,
Elsevier, vol. 141(2), pages 1115-1130, December.
- Peter C.B. Phillips & Sainan Jin & Ling Hu, 2005. "Nonstationary Discrete Choice: A Corrigendum and Addendum," Cowles Foundation Discussion Papers 1516, Cowles Foundation for Research in Economics, Yale University.
- Athanasios Orphanides, 2010.
"Monetary Policy Lessons from the Crisis,"
2010-1, Central Bank of Cyprus.
- Gerdesmeier, Dieter & Roffia, Barbara, 2003.
"Empirical estimates of reaction functions for the euro area,"
Working Paper Series
0206, European Central Bank.
- 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.
- 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.
- Richard Clarida & Jordi Gali & Mark Gertler, 1997. "Monetary Policy Rules in Practice: Some International Evidence," NBER Working Papers 6254, National Bureau of Economic Research, Inc.
- Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers 1750, C.E.P.R. Discussion Papers.
- Clarida, Richard & Gali, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," Working Papers 97-32, C.V. Starr Center for Applied Economics, New York University.
- Graciela Laura Kaminsky, 1997.
"Leading Indicators of Currency Crises,"
IMF Working Papers
97/79, International Monetary Fund.
- Kaminsky, Graciela & Lizondo, Saul & Reinhart, Carmen M., 1997. "Leading indicators of currency crises," Policy Research Working Paper Series 1852, The World Bank.
- Reinhart, Carmen & Kaminsky, Graciela & Lizondo, Saul, 1998. "Leading Indicators of Currency Crises," MPRA Paper 6981, University Library of Munich, Germany.
- Michael Woodford, 2003.
"Optimal Interest-Rate Smoothing,"
Review of Economic Studies,
Wiley Blackwell, vol. 70(4), pages 861-886, October.
- John S. Lapp & Douglas K. Pearce & Surachit Laksanasut, 2003. "The Predictability of FOMC Decisions: Evidence from the Volcker and Greenspan Chairmanships," Southern Economic Journal, Southern Economic Association, vol. 70(2), pages 312-327, October.
- Jamie Gascoigne & Paul Turner, 2004.
"Asymmetries in Bank of England monetary policy,"
Applied Economics Letters,
Taylor and Francis Journals, vol. 11(10), pages 615-618.
- Michael Dueker, 1999. "Measuring monetary policy inertia in target Fed funds rate changes," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 3-10.
- Glenn D. Rudebusch, 2006.
"Monetary Policy Inertia: Fact or Fiction?,"
International Journal of Central Banking,
International Journal of Central Banking, vol. 2(4), December.
- David-Jan Jansen & Jakob De Haan, 2009. "Has ECB communication been helpful in predicting interest rate decisions? An evaluation of the early years of the Economic and Monetary Union," Applied Economics, Taylor and Francis Journals, vol. 41(16), pages 1995-2003.
- Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
- Berger, Helge & Ehrmann, Michael & Fratzscher, Marcel, 2009. "Forecasting ECB monetary policy: Accuracy is a matter of geography," European Economic Review, Elsevier, vol. 53(8), pages 1028-1041, November.
- Janko Gorter & Jan Jacobs & Jakob de Haan, 2008. "Taylor Rules for the ECB using Expectations Data," Scandinavian Journal of Economics, Wiley Blackwell, vol. 110(3), pages 473-488, 09.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.