TAYLOR RULES AND INTEREST RATE SMOOTHING IN THE EURO AREA*

Efrem Castelnuovo

Manchester School, 2007, vol. 75, issue 1, 1-16

Abstract: Conventional wisdom suggests that central banks implement monetary policy in a gradual fashion. Some researchers claim that this gradualism is due to ‘optimal cautiousness’; in contrast, Rudebusch (Journal of Monetary Economics, Vol. 49 (2002), pp. 1161–1187) states that the observed policy rate sluggishness is mainly due to serially correlated exogenous shocks. In this paper we use models in first differences to assess the ‘endogenous’ versus ‘exogenous’ gradualism hypothesis for the Euro area. Our results suggest that the joint formalization of the two hypotheses is likely to offer the best simple approximation of the Euro area monetary policy conduct.

Date: 2007
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