Estimating the ECB Policy Reaction Function

Abstract

This paper estimates the policy reaction function of the European Central Bank in the first four years of EMU using an ordered probit model which accounts for the fact that central bank rates are set at multiples of 25 basis points. Starting from a baseline model which mimics the Taylor rule, the impacts of different economic variables on interest rate decisions are analysed. It is concluded that the monetary growth measure which was announced by the ECB as the first pillar of their monetary strategy does not play an outstanding role for the actual interest rate decisions. More sophisticated measures like the money overhang which uses information from both pillars are better suited. Overall, it is concluded that the revision of the monetary policy strategy in May 2003 which implied a downgrading of the first pillar will not induce any observable changes in monetary policy decisions. Copyright Verein für Socialpolitik and Blackwell Publishing Ltd. 2006.

An ordered probit analysis of monetary policy inertia

“…The backward-looking structure is admissible, as it employs the same observed values on which forward-looking rules rely as instruments. Dueker (1999), Choi (1999), andCarstensen (2006) use similar backward-looking models in which historical data serve as both a measure of past experience and a proxy for expectations of future.…”

Quantifying the European Central Bank's Interest Rate Smoothing Behavior*

“…9 The adequate econometric model for such a variable is an ordered response model, see, e.g. Carstensen (2006) or Gerlach (2007), who use ordered probit models to estimate the reaction function of the ECB. = − * is constructed by using the annual rate of change of the Harmonized Index of Consumer Prices (HICP, overall index with changing Euro Area composition; Key: ICP.M.U2.N.000000.4.ANR) and subtracting the inflation target of two per cent.…”

“…9 9 The adequate econometric model for such a variable is an ordered response model, see, e.g. Carstensen (2006) or Gerlach (2007), who use ordered probit models to estimate the reaction function of the ECB. …”

Modelling the monetary policy reaction function of the Colombian Central Bank

“…Thus, in this paper, we postulate a dynamic ordered probit model for the dependent variable, which classifies changes in the Bank rate into three categories, depending on whether the rate was cut by at least 25 basis points, not changed, or increased by at least 25 basis points. This modelling approach has been previously applied by Eichengreen, Watson, and Grossman (1985), Davutyan and Parke (1995), Choi (1999), Dolado, Marı´a-Dolores, and Naveira (2005), and Carstensen (2006), among others, to estimate interest rate-setting behaviour by different central banks (Banco de Espan˜a, Bank of England, Banque de France, Bundesbank, European Central Bank, and the US Federal Reserve) over different time periods.…”