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Interest rate reaction functions and the Taylor rule in the euro area

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  • Gerlach-Kristen, Petra

Abstract

Traditional Taylor rules, which are estimated using a level specification linking the short-term interest rate to inflation and the output gap, are unstable when estimated on euro area data and forecast poorly out of sample. We present an alternative reaction function which takes the non-stationarity of the data into account. The estimated interest rate rule is stable and forecasts well. In contrast to the traditional Taylor rule, we find a significant role for the long rate, which we argue reflects shifts in the public's perception of the long-run inflation objective. JEL Classification: C22, E52

Suggested Citation

  • Gerlach-Kristen, Petra, 2003. "Interest rate reaction functions and the Taylor rule in the euro area," Working Paper Series 258, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:2003258
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    References listed on IDEAS

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    More about this item

    Keywords

    cointegration; ECB; Taylor rule;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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