The US Federal Reserve cut interest rates more vigorously in the recent recession than the European Central Bank did. By comparison with the Fed, the ECB followed a more measured course of action. We use an estimated dynamic general equilibrium model with financial frictions to show that comparisons based on such simple metrics as the variance of policy rates are misleading. We find that - because there is greater inertia in the ECB's policy rule - the ECB's policy actions actually had a greater stabilizing effect than did those of the Fed. As a consequence, a potentially severe recession turned out to be only a slowdown, and inflation never departed from levels consistent with the ECB's quantitative definition of price stability. Other factors that account for the different economic outcomes in the Euro Area and US include differences in shocks and differences in the degree of wage and price flexibility.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
13521.
Length: Date of creation: Oct 2007 Date of revision: Handle: RePEc:nbr:nberwo:13521
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Find related papers by JEL classification: C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation 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 F0 - International Economics - - General F00 - International Economics - - General - - - General
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