Interest rate reaction functions and the Taylor rule in the euro area

Petra Gerlach-Kristen

No 258, Working Paper Series from European Central Bank

Abstract: Traditional Taylor rules, which are estimated using a level specification linking the short-term interest rate to inflation and the output gap, are unstable when estimated on euro area data and forecast poorly out of sample. We present an alternative reaction function which takes the non-stationarity of the data into account. The estimated interest rate rule is stable and forecasts well. In contrast to the traditional Taylor rule, we find a significant role for the long rate, which we argue reflects shifts in the public's perception of the long-run inflation objective. JEL Classification: C22, E52

Keywords: cointegration; ECB; Taylor rule (search for similar items in EconPapers)
Date: 2003-09
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Citations: View citations in EconPapers (89)

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