Taylor rules and monetary policy in the Eurozone

Abstract

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.