Re-examining the ECB’s two-pillar monetary policy strategy: Are there any deviations during and the pre-financial crisis periods?

This paper addresses the extent to which the ECB rate setting responded to inflation and monetary growth in the run up to, and during, the financial crisis of the late 2000s. The analysis covers the period between 1999:01 and 2013:12, split into pre-crisis and financial crisis periods using a structural break test. In addition, a number of specifications are examined, including those in which only positive or negative policy rate changes are used as the dependent variable. An ordered probit model is used as it is deemed more appropriate for modelling discrete economic behaviour, such as policy rate changes, than continuous time series methods. The results from the pre-crisis period show that, although the monetary aggregate was significant in models that incorporate all the policy changes, but when considering just positive policy rate changes, the coefficient for monetary growth is not only small, but also statistically insignificant. Hence, this casts doubt on the extent to which monetary growth influenced the ECB policy rate decisions prior to the financial crisis. The monetary growth coefficients for the crisis period are also found to be insignificant. However, unlike during the pre-crisis period, the coefficient for inflation is found to be both positive and statistically significant, thus confirming qualitative perceptions that the ECB prioritised its price-stability mandate over concerns that the Euro Area sovereign debt crisis.