Assessing monetary rules performance across EMU countries

Abstract

The topic covered in this paper is the performance of different monetary policy rules used as guidelines in practical policy making. To this end, different rules are evaluated using alternative econometrics techniques. A comparative analysis is made of the ability of the rules to correspond to the historical central bank behaviour and of the volatility of output, inflation and interest rate changes that they imply. The study is conducted of the EMU countries. The results suggest that simple rules perform quite well and that the advantages obtained from adopting an optimal control-based rule are not so great. Moreover, the addition of a forward-looking dimension and of an interest rate smoothing term in the reaction function seems to improve the performance of the rules. Copyright © 2003 John Wiley & Sons, Ltd.

Interactions between monetary and fiscal policies

“…Regarding monetary policy, it can be observed that reaction functions are usually based on interest rates. Altavilla (2003) estimates several reaction functions in order to assess how the European Central Bank (ECB) should control interest rates when facing a change in real output, inflation, or the exchange rate. The conclusions are that central bank behaviour is better explained by adding a lagged interest rate and future inflation movements; Ruth (2007) develops a panel reaction function based on the Taylor rule for analysing the European monetary policy.…”

“…Regarding the explanatory variables, for instance, Huchet (2003) uses lagged short-term interest rate, inflation gap and the M3 growth gap compared to its 2% target and a 4.5% reference value, respectively, and the output gap. Altavilla (2003) creates instrument rules which vary between inflation, output gap, and interest rate, as well as their lagged values and an autoregressive term. In addition, some literature highlights the importance of considering external variables as the current account balance and real effective exchange rates to achieve a better assessment of monetary policy dynamics (see, for instance, Kara & Nelson, 2003;Monacelli, 2005;Corsetti & Pesenti, 2005;Kirsanova, Leith, & Wren-Lewis, 2006, and;Leith & Wren-Lewis, 2007).…”

The Effects of Monetary Policy on Unemployment Dynamics under Model Uncertainty: Evidence from the United States and the Euro Area

“…While the inclusion of an exchange rate might not be suitable for the United States (e.g., Taylor 2001), it might nonetheless be appropriate for the euro area (e.g., Peersman and Smets 2003, Altavilla 2003). In any case, its inclusion is intended to reflect the external environment, as well as its conditionality role for monetary policy, as it is an important part of the monetary transmission mechanism in an open economy.…”

Interactions between Monetary Policy and Fiscal Policy

“…Moving to monetary policy, it can be observed that reaction functions are usually based on interest rates. Altavilla (2003) (IE, 1981) 180.332 (UK,2009) 543 8…”

“…reference value, respectively, and also the output gap. Altavilla (2003) creates instrument rules which vary between inflation, output gap and interest rate, and their lagged values and an autoregressive term.…”