Macroeconomic Volatility Trade-Off and Monetary Policy Regime in the Euro Area
46 Pages Posted: 24 Jan 2003
Date Written: November 2002
This research uncovers a well-defined monetary policy regime starting in 1986 in the aggregate Euro Area. Both alternative solution-estimation methods employed - optimal control cum GMM, and dynamic programming cum FIML - identify a regime of strict inflation targeting with interest rate smoothing. The unemployment gap, properly estimated as quasi real-time information, is a relevant element in the information set of the monetary authority, despite not being included in its preferences. The emergence of the regime relates to the improvement of the volatility trade-off between inflation and unemployment gap since the mid-80s. Additional improving factors have been milder supply shocks and better ability of policymakers to set the interest rate closer to optimum.
Keywords: Monetary Policy Regime, Euro Area, Optimal Control, Dynamic Programming, GMM, FIML
JEL Classification: E52, E58, C32, C61
Suggested Citation: Suggested Citation