Financial Market Conditions, Real Time, Nonlinearity and European Central Bank Monetary Policy: In-Sample and Out-of-Sample Assessment

Costas Milas and Ruthira Naraidoo ()
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Ruthira Naraidoo: Department of Economics, University of Pretoria

No 200923, Working Papers from University of Pretoria, Department of Economics

Abstract: We explore how the ECB sets interest rates in the context of policy reaction functions. Using both real-time and revised information, we consider linear and nonlinear policy functions in inflation, output and a measure of financial conditions. We find that amongst Taylor rule models, linear and nonlinear models are empirically indistinguishable within sample and that model specifications with real-time data provide the best description of in-sample ECB interest rate setting behavior. The 2007-2009 financial crisis witnesses a shift from inflation targeting to output stabilisation and a shift, from an asymmetric policy response to financial conditions at high inflation rates, to a more symmetric response irrespectively of the state of inflation. Finally, without imposing an a priori choice of parametric functional form, semiparametric models forecast out-of-sample better than linear and nonlinear Taylor rule models.

Keywords: monetary policy; nonlinearity; real time data; financial conditions (search for similar items in EconPapers)
JEL-codes: C51 C52 C53 E52 E58 (search for similar items in EconPapers)
Date: 2009-10

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Persistent link: http://EconPapers.repec.org/RePEc:pre:wpaper:200923

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