What Does “Below, But Close to, Two Percent” Mean? Assessing the Ecb's Reaction Function with Real Time Data

43 Pages Posted: 9 Oct 2017 Last revised: 7 May 2019

See all articles by Maritta Paloviita

Maritta Paloviita

Bank of Finland - Research

Markus Haavio

Bank of Finland - Research

Pirkka Jalasjoki

Bank of Finland - Research

Juha Kilponen

Bank of Finland - Research

Date Written: October 5, 2017

Abstract

We estimate the ECB’s monetary policy reaction function by using real time Eurosystem/ECB staff macroeconomic projection data, which are presented to the ECB’s Governing Council when it assesses the monetary policy stance in the euro area. Alternative specifications of the reaction function account for a possible credibility loss due to persistent deviations of past inflation from the ECB’s inflation target. The results provide support for two alternative interpretations of the definition of price stability. First, the ECB dislikes inflation rates above two percent more than rates below two percent. Second, the ECB policy responses to past inflation gaps are symmetric with respect to a target of 1.6 - 1.7 percent. The out-of-sample predictions of the reaction function based on the second interpretation of the definition of price stability track well an estimated shadow interest rate during the zero lower bound period.

Keywords: credibility, inflation target, monetary policy, realtime projections, Taylor rule

JEL Classification: E52, E58

Suggested Citation

Paloviita, Maritta and Haavio, Markus and Jalasjoki, Pirkka and Kilponen, Juha, What Does “Below, But Close to, Two Percent” Mean? Assessing the Ecb's Reaction Function with Real Time Data (October 5, 2017). Bank of Finland Research Discussion Paper No. 29/2017. Available at SSRN: https://ssrn.com/abstract=3049503

Maritta Paloviita (Contact Author)

Bank of Finland - Research ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland
+358 9 1831 (Phone)
+358 9 1832560 (Fax)

Markus Haavio

Bank of Finland - Research ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

Pirkka Jalasjoki

Bank of Finland - Research ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

Juha Kilponen

Bank of Finland - Research ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland
+358 10 831 2847 (Phone)
+358 10 831 2294 (Fax)

HOME PAGE: http://www.bof.fi/en/suomen_pankki/organisaatio/asiantuntijoita/kilponen_juha/

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
33
Abstract Views
226
PlumX Metrics