ECB vs Bundesbank's monetary policy

The monetary policy of the ECB and that of Bundesbank can be interpreted in terms of the Taylor rule framework with surprising consistency. The estimated equations indicate that the rules examined describe broadly the time path of policy decisions quite close. The responses to output gap and to movements in the price level are as expected. The magnitude of the response to inflation is in line with the classical formulation of the Taylor rule but it is not in line with the assumed inflation targeting monetary policy.

The findings are in line with studies in this area that suggest that since the introduction of the euro and the conduct of a single monetary policy, in the Euro Area the monetary policy is rather accommodative than stabilizing (K. Ulrich, 2003). Taking into account the findings of other papers, one can easily see that the Taylor rule can be used as a framework in order to evaluate the interest rate setting mechanism in the Euro Area, but no one would make a profit out of such a strategy, as the rule does not fit the data as well as it did for the sample taken into consideration by Taylor’s original paper. The evidence suggests also that there is a significant difference between the monetary policy in the Euro area during the office of W. Druisenberg and the monetary policy conducted under J.C.Trichet.

The empirical evidence suggests that the interest rates in the euro area are in line with the levels the framework would predict, suggesting a rather accommodative monetary policy of the ECB. There is a greater weight on the output gap than the focus on inflationary pressures, in contrast with the Bundesbank monetary policy, which follows a strict inflation targeting regime. In fact, the ECB is following a “flexible inflation targeting”, having inflation stability as a primary goal and putting some weight on stabilizing output movements.

By developig a policy reaction function that includes M3 growth and productivity in addition to the inflation rates and output gap, the thesis finds that such a model is a better fit to describe the level of the main refinancing rates in the Euro Area.