How the ECB and the US Fed set interest rates

Ansgar Hubertus Belke · Thorsten Polleit

88 citations0/0 files storedApplied Economics

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Monetary Policy and Economic Impact Global Financial Crisis and Policies European Monetary and Fiscal Policies

Abstract

Monetary policies of the European Central Bank (ECB) and US Fed can be characterized by ‘Taylor rules’, that is both central banks seem to be setting rates by taking into account the ‘output gap’ and inflation. We also set up and tested Taylor rules which incorporate money growth and the euro–dollar exchange rate, thereby improving the ‘fit’ between actual and Taylor rule based rates. In general, Taylor rules appear to be a much better way of describing Fed policy than ECB policy. Simulations suggest that the ECB's short-term interest rates have been at a much lower level in the last 2 years compared with what a Taylor rule would suggest.

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References

1993Discretion versus policy rules in practice 1999The Science of Monetary Policy: A New Keynesian Perspective 2000Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory*1998Monetary policy rules in practice 1999Monetary Policy Rules 1995The Mirage of Fixed Exchange Rates 2001The Taylor Rule and Optimal Monetary Policy 2002Term structure evidence on interest rate smoothing and monetary policy inertia

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