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UNVEILING THE MONETARY POLICY RULE

IN THE EURO-AREA

  

 

Thanassis Kazanas

Athens University of Economics and Business,

 

Elias Tzavalis

Athens University of Economics and Business,

 

 

ABSTRACT

This paper provides evidence that, since the sign of Maastricht Treaty, euro-area monetary authorities mainly follow a strong anti-inflationary policy. This policy can be described by a threshold monetary policy rule model which allows for distinct inflation policy regimes: a low and high. The paper finds that these authorities react more strongly to positive deviations of inflation and/or output from their target levels rather than to the negative. They do not seem to react at all to negative deviations of output from its target level in the low-inflation regime. We argue that this behaviour can be attributed to the attitude of the monetary authorities to build up credibility on stabilizing inflationary expectations. To evaluate the policy implications of the above euro-area monetary policy rule behaviour, the paper simulates a small New Keynesian model. This exercise clearly indicates that the absence of reaction of the euro-area monetary authorities to negative output gap when inflation is very low reduces their efficiency on dampening the effects of negative demand shocks on the economy.

 

JEL Classification: E52, C13, C30

 

Keywords: Monetary policy, threshold models, regime-switching, generalized method of moments, New Keynesian model

 

Acknowledgements: The authors would like to thank Heather Gibson, Alex Michaelides, George Tavlas, as well as the participants at the seminar series of the Bank of Greece for helpful comments on an earlier version of the paper. Thanassis Kazanas also acknowledges financial support from the Bank of Greece for carrying out this research. The views expressed do not necessarily reflect those of the Bank of Greece.

 

 

Correspondence:

Thanassis Kazanas
Athens
University of Economics and Business,

Department of Economics,

76 Patission Str., 104 34,

Athens, Greece. Email: tkazanas@aueb.gr


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