An Empirical Assessment of Optimal Monetary Policy in the Euro Area

39 Pages Posted: 7 Feb 2015 Last revised: 22 May 2017

See all articles by Xiaoshan Chen

Xiaoshan Chen

University of Stirling

Tatiana Kirsanova

University of Glasgow - Adam Smith Business School

Campbell Leith

University of Glasgow - Department of Economics

Date Written: May 16, 2017

Abstract

We estimate a New Keynesian DSGE model for the Euro area under alternative descriptions of monetary policy (discretion, commitment or a simple rule) after allowing for Markov switching in policy-maker preferences and shock volatilities. This reveals that there have been several changes in Euro-area policy making, with a strengthening of the anti-inflation stance in the early years of the ERM, which was then lost around the time of German reunification and only recovered following the turmoil in the ERM in 1992. The ECB does not appear to have been any more conservative as aggregate Euro-area policy was under Bundesbank leadership. The estimates also suggest that the most appropriate description of policy is that of discretion, with no evidence of commitment in the Euro-area. As a result, although both ‘good luck’ and ‘good policy’ played a role in the moderation of inflation and output volatility in the Euro-area, the welfare gains would have been substantially higher had policy makers been able to commit. Adopting a flexible price level target would lead to outcomes close to commitment.

Keywords: Bayesian Estimation, Interest Rate Rules, Optimal Monetary Policy, Great Moderation, Commitment, Discretion, Zero Lower Bound, Financial Crisis, Great Recession

JEL Classification: E58, E32, C11, C51, C52, C54

Suggested Citation

Chen, Xiaoshan and Kirsanova, Tatiana and Leith, Campbell, An Empirical Assessment of Optimal Monetary Policy in the Euro Area (May 16, 2017). Available at SSRN: https://ssrn.com/abstract=2561078 or http://dx.doi.org/10.2139/ssrn.2561078

Xiaoshan Chen

University of Stirling ( email )

Stirling, Scotland FK9 4LA
United Kingdom

HOME PAGE: http://www.stir.ac.uk/management/staff-directory/economics/xiaoshen-chen/

Tatiana Kirsanova (Contact Author)

University of Glasgow - Adam Smith Business School ( email )

Glasgow, Scotland
United Kingdom

Campbell Leith

University of Glasgow - Department of Economics ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom
++44 141 330 3702 (Phone)
++44 141 330 4940 (Fax)

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
92
Abstract Views
647
Rank
506,276
PlumX Metrics