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A speed limit monetary policy rule for the euro area

  • Stracca, Livio

This paper estimates a hybrid New Keynesian model on euro area data and evaluates the performance of different simple policy rules and of the optimal unconstrained rule under commitment. The study reaches two main conclusions. First, inflation is found to be mainly forward-looking in the euro area, which implies the optimal policy reaction to cost push shocks is a muted one. Second, a "speed limit" rule of the type recently proposed by Walsh (2003) is able to closely approximate the performance of the optimal rule under commitment. The optimal speed limit rule is also characterised by super-inertia, making it a first difference rule similar to those recently proposed as a possible solution to measurement problems in the level of the natural interest rate and of potential output. JEL Classification: E52, E58

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Paper provided by European Central Bank in its series Working Paper Series with number 0600.

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Date of creation: Apr 2006
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Handle: RePEc:ecb:ecbwps:20060600
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  1. Bennett T. McCallum & Edward Nelson, 2000. "Timeless Perspectives vs. Discretionary Monetary Policy In Forward-Looking Models," NBER Working Papers 7915, National Bureau of Economic Research, Inc.
  2. Bennett T. McCallum & Edward Nelson, 2004. "Targeting vs. Instrument Rules for Monetary Policy," NBER Working Papers 10612, National Bureau of Economic Research, Inc.
  3. Jordi Galí & Mark Gertler & J. David López-Salido, 2001. "Robustness of the Estimates of the Hybrid New Keynesian Phillips Curve," Working Papers 44, Barcelona Graduate School of Economics.
  4. Glenn D. Rudebusch & Jeffrey C. Fuhrer, 2002. "Estimating the Euler equation for output," Working Paper Series 2002-12, Federal Reserve Bank of San Francisco.
  5. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  6. Coenen, Günter & Wieland, Volker, 2002. "A Small Estimated Euro Area Model with Rational Expectations and Nominal Rigidities," CEPR Discussion Papers 3574, C.E.P.R. Discussion Papers.
  7. S. G. B Henry & A. R. Pagan, 2004. "The Econometrics of the New Keynesian Policy Model: Introduction," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 66(s1), pages 581-607, 09.
  8. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  9. Galí, Jordi & Gertler, Mark & López-Salido, J David, 2001. "European Inflation Dynamics," CEPR Discussion Papers 2684, C.E.P.R. Discussion Papers.
  10. Amato, Jeffery D. & Laubach, Thomas, 2004. "Implications of habit formation for optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 305-325, March.
  11. Athanasios Orphanides & John C. Williams, 2002. "Robust monetary policy rules with unknown natural rates," Working Paper Series 2003-01, Federal Reserve Bank of San Francisco.
  12. Christian Jensen & Bennett C. McCallum, 2002. "The Non-Optimality of Proposed Monetary Policy Rules Under Timeless-Perspective Commitment," NBER Working Papers 8882, National Bureau of Economic Research, Inc.
  13. Rudebusch, Glenn D., 2000. "Assessing nominal income rules for monetary policy with model and data uncertainty," Working Paper Series 0014, European Central Bank.
  14. Laurence Ball, 1997. "Efficient rules for monetary policy," Reserve Bank of New Zealand Discussion Paper Series G97/3, Reserve Bank of New Zealand.
  15. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  16. Lars E.O. Svensson, 2002. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Working Papers 118, Princeton University, Department of Economics, Center for Economic Policy Studies..
  17. Ehrmann, Michael & Smets, Frank, 2003. "Uncertain potential output: implications for monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 27(9), pages 1611-1638, July.
  18. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
  19. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1293-1309, September.
  20. Tommaso PROIETTI & Alberto MUSSO & Thomas WESTERMANN, 2002. "Estimating Potential Output and the Output Gap for the Euro Area: a Model-Based Production Function Approach," Economics Working Papers ECO2002/09, European University Institute.
  21. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  22. Christopher J. Erceg & Andrew T. Levin, 2001. "Imperfect credibility and inflation persistence," Finance and Economics Discussion Series 2001-45, Board of Governors of the Federal Reserve System (U.S.).
  23. Bennett T. McCallum & Edward Nelson, 2005. "Targeting versus instrument rules for monetary policy," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 225-245.
  24. Adalid, Ramon & Coenen, Gunter & McAdam, Peter & Siviero, Stefano, 2005. "The Performance and Robustness of Interest-Rate Rules in Models of the Euro Area," MPRA Paper 821, University Library of Munich, Germany.
  25. Lars E.O. Svensson & Michael Woodford, 2000. "Indicator variables for optimal policy," Proceedings, Federal Reserve Bank of San Francisco.
  26. Forsells, Magnus & Kenny, Geoff, 2002. "The rationality of consumers' inflation expectations: survey-based evidence for the euro area," Working Paper Series 0163, European Central Bank.
  27. Pau Rabanal & Juan Francisco Rubio-Ramirez, 2003. "Comparing New Keynesian models in the Euro area: a Bayesian approach," Working Paper 2003-30, Federal Reserve Bank of Atlanta.
  28. Jón Steinsson, 2000. "Optimal monetary policy in an economy with inflation persistence," Economics wp11, Department of Economics, Central bank of Iceland.
  29. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  30. Orphanides, Athanasios, 2000. "The quest for prosperity without inflation," Working Paper Series 0015, European Central Bank.
  31. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  32. Peersman, Gert & Smets, Frank, 1999. "The Taylor Rule: A Useful Monetary Policy Benchmark for the Euro Area?," International Finance, Wiley Blackwell, vol. 2(1), pages 85-116, April.
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