Taylor Rule in the Eurozone and the US

Using the vector autoregression (VAR) model, we analysed the short-term interbank interest rate changes in the Eurozone and the US. According to recent literature, the Taylor rule is a practical guide and preliminary tool for the central bank’s key policy rate. However, relevant macroeconomic variables need to be considered to obtain a more accurate estimation. The prominent critique of the Taylor rule mentioned the model’s rigid structure, advocating for flexible, scenario-based simulations to generate better insights for central banks. This study shows that the Eurozone and the US short-term interbank interest rate responses are not only driven by the variables of the standard Taylor rule but also by the inflation expectation and the real effective exchange rate (REER). We also find evidence that the inflation expectation better describes the Eurozone short-term interbank interest rate, while the output gap better describes the US short-term interbank interest rate. Such macroeconomic variables had a notable impact on the post-COVID-19 (2020 Q1 to 2024 Q4) pandemic scenario compared to the pre-COVID-19 (2013 Q2 to 2019 Q4) pandemic period. Thus, this paper makes a new contribution to the debate on whether the components of the standard Taylor rule are sufficient to estimate the short-term interbank interest rate or other relevant macroeconomic components, including the economic structure, central bank priority, and unconventional monetary policies, have a significant influence.