Optimal Regional Biases in ECB Interest Rate Setting
NRG Working Paper Series # 05-01
24 Pages Posted: 23 Feb 2006
Date Written: November 2005
This paper uses a simple model of optimal monetary policy to consider whether the influence of national output and inflation rates on ECB interest rate setting should equal a country's weight in the eurozone economy. The findings depend on assumptions regarding interest rate elasticities, exchange rate elasticities, and openness vis-à-vis non-eurozone countries. The major conclusion is that the ECB should respond less to inflation shocks in EMU countries that have strong trading ties with non-eurozone countries. Intuitively, these countries can take care of some of the monetary tightening themselves, through a real appreciation vis-à-vis their non-eurozone trading partners.
Keywords: EMU, Taylor rule, Optimal monetary policy
JEL Classification: E52, E58
Suggested Citation: Suggested Citation