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ECB Reaction Functions and the Crisis of 2008

  • Gerlach, Stefan
  • Lewis, John

We study ECB’s interest rate setting in 1999-2010 using a reaction function in which forecasts of future economic growth and inflation enter as regressors. Allowing for a gradual switch between two reaction functions, we detect a shift after Lehman Brothers failed in September 2008 when the pre-crisis reaction function first indicates that interest rates may become constrained by the zero lower bound. Furthermore, the interest rate cuts in late 2008 were more aggressive than forecast by the pre-crisis reaction function. These findings are compatible with the literature on optimal monetary policy in the presence of a zero lower bound.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8472.

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Date of creation: Jul 2011
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Handle: RePEc:cpr:ceprdp:8472
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  1. Stefan Gerlach & John Lewis, 2010. "The Zero Lower Bound, ECB Interest Rate Policy and the Financial Crisis," DNB Working Papers 254, Netherlands Central Bank, Research Department.
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  5. Janko Gorter & Fauve Stolwijk & Jan Jacobs & Jakob de Haan, 2010. "ECB Policy Making and the Financial Crisis," DNB Working Papers 272, Netherlands Central Bank, Research Department.
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  9. Orphanides, Athanasios & Wieland, Volker, 2000. "Efficient Monetary Policy Design near Price Stability," Journal of the Japanese and International Economies, Elsevier, vol. 14(4), pages 327-365, December.
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  17. McCallum, Bennett T & Nelson, Edward, 2001. "Timeless Perspective Vs Discretionary Monetary Policy in Forward-Looking Models," CEPR Discussion Papers 2752, C.E.P.R. Discussion Papers.
  18. Coenen, Günter, 2003. "Zero lower bound: is it a problem in the euro area?," Working Paper Series 0269, European Central Bank.
  19. Gerlach-Kristen, Petra, 2003. "Interest rate reaction functions and the Taylor rule in the euro area," Working Paper Series 0258, European Central Bank.
  20. Stefan Gerlach, 2007. "Interest Rate Setting by the ECB, 1999-2006: Words and Deeds," International Journal of Central Banking, International Journal of Central Banking, vol. 3(3), pages 1-46, September.
  21. John C. Williams, 2009. "Heeding Daedalus: Optimal Inflation and the Zero Lower Bound," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(2 (Fall)), pages 1-49.
  22. Assenmacher-Wesche, Katrin, 2006. "Estimating Central Banks' preferences from a time-varying empirical reaction function," European Economic Review, Elsevier, vol. 50(8), pages 1951-1974, November.
  23. Chow, Gregory C & Lin, An-loh, 1971. "Best Linear Unbiased Interpolation, Distribution, and Extrapolation of Time Series by Related Series," The Review of Economics and Statistics, MIT Press, vol. 53(4), pages 372-75, November.
  24. Carl Walsh, 2003. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 93(1), pages 265-278, March.
  25. Stefan Gerlach & John Lewis, 2014. "Zero lower bound, ECB interest rate policy and the financial crisis," Empirical Economics, Springer, vol. 46(3), pages 865-886, May.
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