Testing optimal monetary policy in a currency union

Bjarni Einarsson

Economics from Department of Economics, Central bank of Iceland

Abstract: This paper presents a framework for testing the optimality of monetary policy decisions made by a central bank in a monetary union. Applying the framework to test the European Central Bank’s monetary policy decisions we find several instances of optimization failures in its use of the Forward Guidance and Quantitative Easing instruments. We cannot reject optimality in its use of the Target Rate instrument. We find signs of heterogeneity in the optimal prescriptions for the individual member countries with respect to the union level prescription. Additionally, we find many instances of optimization failure at the country level for all instruments. Assuming each country has a country specific version of the union loss function we provide a measure of the cost of abandoning independent monetary policy by joining a union. The results indicate that the price of Euro membership is higher for the peripheral economies.

JEL-codes: C32 E31 E32 E52 E58 E61 E65 (search for similar items in EconPapers)
Date: 2024-08
New Economics Papers: this item is included in nep-cba, nep-eec, nep-eur and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:ice:wpaper:wp96

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