The Taylor Rule: A Useful Monetary Policy Benchmark for the Euro Area?

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Abstract

This paper explores the Taylor rule – defined as an instrument rule linking the central bank's policy rate to the current inflation rate and the output gap – as a benchmark for analysing monetary policy in the euro area. First, it analyses the stabilization properties of the Taylor rule in a closed economy model of the euro area, estimated using aggregate data from five EU countries. An optimized Taylor rule performs quite well compared to the unconstrained optimal feedback rule. Second, the robustness of these results to estimation error in the output gap and model uncertainty is examined

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