IDEAS home Printed from https://ideas.repec.org/p/ecb/ecbwps/2003258.html
   My bibliography  Save this paper

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

Author

Listed:
  • 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
    as

    Download full text from publisher

    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp258.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Coenen, Gunter & Wieland, Volker, 2005. "A small estimated euro area model with rational expectations and nominal rigidities," European Economic Review, Elsevier, vol. 49(5), pages 1081-1104, July.
    2. Claus Brand & Nuno Cassola, 2004. "A money demand system for euro area M3," Applied Economics, Taylor & Francis Journals, vol. 36(8), pages 817-838.
    3. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
    4. Fagan, Gabriel & Henry, Jérôme & Mestre, Ricardo, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series 42, European Central Bank.
    5. Jon Faust & John H. Rogers & Jonathan H. Wright, 2001. "An empirical comparison of Bundesbank and ECB monetary policy rules," International Finance Discussion Papers 705, Board of Governors of the Federal Reserve System (U.S.).
    6. Gert Peersman & Frank Smets, 1999. "The Taylor Rule: A Useful Monetary Policy Benchmark for the Euro Area?," International Finance, Wiley Blackwell, vol. 2(1), pages 85-116, April.
    7. Gerlach, Stefan & Schnabel, Gert, 2000. "The Taylor rule and interest rates in the EMU area," Economics Letters, Elsevier, vol. 67(2), pages 165-171, May.
    8. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
    9. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
    10. Gerdesmeier, Dieter & Roffia, Barbara, 2003. "Empirical estimates of reaction functions for the euro area," Working Paper Series 206, European Central Bank.
    11. Kozicki, Sharon & Tinsley, P. A., 2001. "Shifting endpoints in the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 613-652, June.
    12. Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, vol. 84(Q III), pages 47-64.
    13. Marvin Goodfriend, 1998. "Using the term structure of interest rates for monetary policy," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 13-30.
    14. Hardouvelis, Gikas A., 1994. "The term structure spread and future changes in long and short rates in the G7 countries: Is there a puzzle?," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 255-283, April.
    15. Volker Clausen & Bernd Hayo, 2005. "Monetary policy in the Euro area – lessons from the first years," International Economics and Economic Policy, Springer, vol. 1(4), pages 349-364, January.
    16. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
    17. Kozicki, Sharon & Tinsley, P. A., 2001. "Term structure views of monetary policy under alternative models of agent expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 25(1-2), pages 149-184, January.
    18. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
    19. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Ruth, Karsten, 2004. "Interest rate reaction functions for the euro area Evidence from panel data analysis," Discussion Paper Series 1: Economic Studies 2004,33, Deutsche Bundesbank.
    2. Luís, Pacheco, 2004. "Asset Prices and Monetary Policy in the Euro Area: a tentative model," MPRA Paper 6579, University Library of Munich, Germany.
    3. Ansgar Belke & Thorsten Polleit, 2007. "How the ECB and the US Fed set interest rates," Applied Economics, Taylor & Francis Journals, vol. 39(17), pages 2197-2209.
    4. Stephan Sauer & Jan-Egbert Sturm, 2003. "Using Taylor Rules to Understand ECB Monetary Policy," CESifo Working Paper Series 1110, CESifo.
    5. Coenen, Gunter & Wieland, Volker, 2005. "A small estimated euro area model with rational expectations and nominal rigidities," European Economic Review, Elsevier, vol. 49(5), pages 1081-1104, July.
    6. Ansgar Belke & Wim Kösters & Martin Leschke & Thorsten Polleit, 2005. "Back to the rules," Diskussionspapiere aus dem Institut für Volkswirtschaftslehre der Universität Hohenheim 268/2005, Department of Economics, University of Hohenheim, Germany.
    7. Leon, Costas, 2006. "The Taylor rule: can it be supported by the data?," MPRA Paper 1650, University Library of Munich, Germany.
    8. repec:kap:iaecre:v:14:y:2008:i:2:p:156-166 is not listed on IDEAS
    9. Fourcans, Andre & Vranceanu, Radu, 2004. "The ECB interest rate rule under the Duisenberg presidency," European Journal of Political Economy, Elsevier, vol. 20(3), pages 579-595, September.
    10. Efrem Castelnuovo, 2003. "Taylor Rules and Interest Rate Smoothing in the US and EMU," Macroeconomics 0303002, University Library of Munich, Germany.
    11. Gerlach, Stefan, 2004. "Interest Rate Setting by the ECB: Words and Deeds," CEPR Discussion Papers 4775, C.E.P.R. Discussion Papers.
    12. Rafael Domenech & Mayte Ledo & David Taguas, 2001. "A Small Forward-Looking Macroeconomic Model for EMU," Working Papers 0102, BBVA Bank, Economic Research Department.
    13. Gerdesmeier, Dieter & Roffia, Barbara, 2005. "The relevance of real-time data in estimating reaction functions for the euro area," The North American Journal of Economics and Finance, Elsevier, vol. 16(3), pages 293-307, December.
    14. Karsten Ruth, 2007. "Interest rate reaction functions for the euro area," Empirical Economics, Springer, vol. 33(3), pages 541-569, November.
    15. repec:hal:spmain:info:hdl:2441/5221 is not listed on IDEAS
    16. Nejla Adanur Aklan & Mehmet Nargelecekenler, 2008. "Taylor Rule in Practice: Evidence from Turkey," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 14(2), pages 156-166, May.
    17. Tobias Rühl, 2015. "Taylor rules revisited: ECB and Bundesbank in comparison," Empirical Economics, Springer, vol. 48(3), pages 951-967, May.
    18. Wieland, Volker & Wolters, Maik, 2013. "Forecasting and Policy Making," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 2, chapter 0, pages 239-325, Elsevier.
    19. Hidi, János, 2006. "A magyar monetáris politikai reakciófüggvény becslése [Estimating the reaction function for Hungarian monetary policy]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(12), pages 1178-1199.
    20. repec:spo:wpmain:info:hdl:2441/5221 is not listed on IDEAS
    21. Stephan Sauer & Jan‐Egbert Sturm, 2007. "Using Taylor Rules to Understand European Central Bank Monetary Policy," German Economic Review, Verein für Socialpolitik, vol. 8(3), pages 375-398, August.
    22. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
    23. Kozicki, Sharon & Tinsley, P.A., 2005. "Permanent and transitory policy shocks in an empirical macro model with asymmetric information," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1985-2015, November.

    More about this item

    Keywords

    cointegration; ECB; Taylor rule;
    All these keywords.

    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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ecb:ecbwps:2003258. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Official Publications (email available below). General contact details of provider: https://edirc.repec.org/data/emieude.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.