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Explaining ECB and Fed interest rate correlation: Economic interdependence and optimal monetary policy

  • Mandler, Martin

This paper studies whether the observed high correlation between monetary policy in the U.S. and the Euro area can be explained by economic fundamentals, i.e. by macroeconomic interdependence between the two regions. We show that an optimal monetary policy reaction function for the ECB that accounts explicitly for economic interrelationships between the two economies reproduces substantial parts of the observed patterns of interest rate correlation and represents a good approximation to the actually observed monetary policy of the ECB. It implies strong reactions to shocks to US variables, particularly to shocks to the Federal Funds Rate.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 25929.

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Date of creation: Oct 2010
Date of revision:
Handle: RePEc:pra:mprapa:25929
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  1. Chiara Scotti, 2006. "A bivariate model of Fed and ECB main policy rates," International Finance Discussion Papers 875, Board of Governors of the Federal Reserve System (U.S.).
  2. Glenn D. Rudebusch & Lars E. O. Svensson, 1999. "Eurosystem monetary targeting: lessons from U.S. data," Working Paper Series 99-13, Federal Reserve Bank of San Francisco.
  3. John P. Judd & Glenn D. Rudebusch, 1998. "Taylor's rule and the Fed, 1970-1997," Economic Review, Federal Reserve Bank of San Francisco, pages 3-16.
  4. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
  5. Richard Dennis, 2006. "The policy preferences of the US Federal Reserve," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(1), pages 55-77.
  6. Ansgar Belke & Daniel Gros, 2005. "Asymmetries in Transatlantic Monetary Policy-making: Does the ECB Follow the Fed?," Journal of Common Market Studies, Wiley Blackwell, vol. 43(5), pages 921-946, December.
  7. David O. Cushman & Tao Zha, 1995. "Identifying monetary policy in a small open economy under flexible exchange rates," FRB Atlanta Working Paper 95-7, Federal Reserve Bank of Atlanta.
  8. 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.
  9. Söderström, Ulf, 1999. "Monetary policy with uncertain parameters," Working Paper Series 83, Sveriges Riksbank (Central Bank of Sweden).
  10. Rudebusch, Glenn D, 2005. "Assessing the Lucas Critique in Monetary Policy Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 245-72, April.
  11. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc.
  12. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August.
  13. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
  14. Lars E O Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Bank of England working papers 56, Bank of England.
  15. Glenn D. Rudebusch, 2001. "Is The Fed Too Timid? Monetary Policy In An Uncertain World," The Review of Economics and Statistics, MIT Press, vol. 83(2), pages 203-217, May.
  16. Ansgar Belke & Yuhua Cui, 2010. "US-Euro Area Monetary Policy Interdependence: New Evidence from Taylor Rule-based VECMs," The World Economy, Wiley Blackwell, vol. 33(5), pages 778-797, 05.
  17. Sean Collins & Pierre L. Siklos, 2004. "Optimal Monetary Policy Rules and Inflation Targets: Are Australia, Canada, and New Zealand Different from the U.S.?," Open Economies Review, Springer, vol. 15(4), pages 347-362, October.
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  19. Vittorio Grilli & Nouriel Roubini, 1995. "Liquidity and Exchange Rates: Puzzling Evidence from the G-7 Countries," Working Papers 95-17, New York University, Leonard N. Stern School of Business, Department of Economics.
  20. Fritz Breuss, 2002. "Was ECB's monetary policy optimal?," Atlantic Economic Journal, International Atlantic Economic Society, vol. 30(3), pages 298-319, September.
  21. Richard Dennis, 2003. "Inferring policy objectives from economic outcomes," Working Paper Series 2003-05, Federal Reserve Bank of San Francisco.
  22. Stefano Neri & Andrea Nobili, 2010. "The Transmission of US Monetary Policy to the Euro Area," International Finance, Wiley Blackwell, vol. 13(1), pages 55-78, 03.
  23. Kim, Soyoung & Roubini, Nouriel, 2000. "Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 561-586, June.
  24. Favero, Carlo A & Rovelli, Riccardo, 2003. " Macroeconomic Stability and the Preferences of the Fed: A Formal Analysis, 1961-98," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 545-56, August.
  25. Fritz Breuss, 2002. "Was ECB's Monetary Policy Optimal?," WIFO Working Papers 173, WIFO.
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  27. Mandler, Martin, 2009. "In search of robust monetary policy rules - Should the Fed look at money growth or stock market performance?," Journal of Macroeconomics, Elsevier, vol. 31(2), pages 345-361, June.
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  29. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
  30. Ansgar Belke, 2002. "Does the ECB Follow the FED?," Diskussionspapiere aus dem Institut für Volkswirtschaftslehre der Universität Hohenheim 211/2002, Department of Economics, University of Hohenheim, Germany.
  31. Arturo Estrella & Jeffrey C. Fuhrer, 2003. "Monetary Policy Shifts and the Stability of Monetary Policy Models," The Review of Economics and Statistics, MIT Press, vol. 85(1), pages 94-104, February.
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  33. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  34. Andrea Brischetto & Graham Voss, 1999. "A Structural Vector Autoregression Model of Monetary Policy in Australia," RBA Research Discussion Papers rdp1999-11, Reserve Bank of Australia.
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