What does "below, but close to, two percent" mean? Assessing the ECB's reaction function with real time data

Maritta Paloviita, Markus Haavio, Pirkka Jalasjoki and Juha Kilponen

No 29/2017, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: We estimate the ECB's monetary policy reaction function by using real time Eurosystem/ECB staff macroeconomic projection data, which are presented to the ECB's Governing Council when it assesses the monetary policy stance in the euro area. Alternative specifications of the reaction function account for a possible credibility loss due to persistent deviations of past inflation from the ECB's inflation target. The results provide support for two alternative interpretations of the definition of price stability. First, the ECB dislikes inflation rates above two percent more than rates below two percent. Second, the ECB policy responses to past inflation gaps are symmetric with respect to a target of 1.6 - 1.7 percent. The out-of-sample predictions of the reaction function based on the second interpretation of the definition of price stability track well an estimated shadow interest rate during the zero lower bound period.

JEL-codes: E52 E58 (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofrdp:rdp2017_029

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