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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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File URL: http://mpra.ub.uni-muenchen.de/25929/2/MPRA_paper_25929.pdf
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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
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Handle: RePEc:pra:mprapa:25929
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  20. 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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  24. Richard Dennis, 2003. "Inferring policy objectives from economic outcomes," Working Paper Series 2003-05, Federal Reserve Bank of San Francisco.
  25. Cushman, David O. & Zha, Tao, 1997. "Identifying monetary policy in a small open economy under flexible exchange rates," Journal of Monetary Economics, Elsevier, vol. 39(3), pages 433-448, August.
  26. 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.
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  29. 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.).
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