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Unveiling the monetary policy rule in euro area

  • Thanassis Kazanas


    (Athens University of Economics and Business)

  • Elias Tzavalis

    (Athens University of Economics and Business)

This paper provides evidence that, since the sign of Maastricht Treaty, euro-area monetary authorities mainly follow a strong anti-inflationary policy. This policy can be described by a threshold monetary policy rule model which allows for distinct inflation policy regimes: a low and high. The paper finds that these authorities react more strongly to positive deviations of inflation and/or output from their target levels rather than to the negative. They do not seem to react at all to negative deviations of output from its target level in the low-inflation regime. We argue that this behaviour can be attributed to the attitude of the monetary authorities to build up credibility on stabilizing inflationary expectations. To evaluate the policy implications of the above euro-area monetary policy rule behaviour, the paper simulates a small New Keynesian model. This exercise clearly indicates that the absence of reaction of the euro-area monetary authorities to negative output gap when inflation is very low reduces their efficiency on dampening the effects of negative demand shocks on the economy.

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Paper provided by Bank of Greece in its series Working Papers with number 130.

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Length: 44
Date of creation: May 2011
Date of revision:
Handle: RePEc:bog:wpaper:130
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