Taylor rules and monetary policy in the Eurozone

2016

In this thesis, we analyse the monetary policy in the Eurozone since the origin of the euro.

The aim of the thesis is to assess whether, and to what extent, the common monetary policy

of the Eurozone has contributed to stabilization of business cycles within the various

economies.

By utilizing alternative versions of the Taylor rule, we have calculated several Taylor-rates

for each of the member states in the Eurozone, which in turn are compared to the actual

interest rate path from the European Central Bank (ECB). Deviation between the Taylorrates

and the actual policy rate is used to analyse the suitability of the common monetary

policy for each member country.

The thesis also discusses the notion of the Eurozone constituting a good approximation to an

optimum currency area by comparing the deviations between the Taylor-rates and the policy

rate with developments in other macro-variables.

A key variable that has implications for our results was the neutral real rate of interest. When

assuming a constant neutral rate, we find that in the first decade of the euro the policy rate

set by the ECB was much closer to the suggested rates of the core-countries than for the

peripheral-countries. The Taylor rule suggests that the monetary policy was too

accommodative for the peripheral-countries during this period. In the period after the

financial crisis it seems that the monetary policy was too strict for the peripheral-countries,

whilst being too accommodative for the core-countries.

Estimations of the neutral real rate using the Laubach-Williams - model show that an

assumed value of the neutral real rate equal to 2% was a fairly good assumption for the corecountries,

such as Germany, France, Belgium, Netherland and Austria. However, in the

peripheral-countries the fluctuations of the neutral real rate have been far greater over the

entire period. This adds to the notion that the perceived stability of the Eurozone during

some time intervals has mainly been a feature of the core countries.

We also calculate Taylor-rates using country-specific estimates of the neutral real rate. The

main features of the country-specific Taylor-rates remain unchanged when compared to the

Taylor-rates which assumed a common constant neutral real rate.