A Speed Limit Monetary Policy Rule for the Euro Area

Authors


  • *The author wishes to thank several colleagues at the European Central Bank (ECB) for valuable comments on previous versions of the paper, in particular Huw Pill, Oreste Tristani, Alessandro Calza and Claus Brand. This paper is partly based on previous work undertaken together with Beatrice Pierluigi (ECB), which was presented at the Oswald Distinguished Speaker Seminar at the University of Kansas on 22 October 2004. The views expressed in this paper are only of the author and are not necessarily shared by the ECB.

Livio Stracca
European Central Bank (ECB)
Kaiserstrasse 29
60311 Frankfurt am Main
Germany
livio.stracca@ecb.int

Abstract

The main task of central banks is to set the level of short-term nominal interest rates in reaction to economic developments, with the aim of achieving their statutory objectives (typically some combination of inflation and output variability). If agents are forward-looking, central banks can achieve better macroeconomic outcomes by committing to follow a rule-like behaviour. Against this background, the contribution of this paper is twofold. First, it estimates a small-scale model of the euro area economy that can be used as a benchmark for the evaluation of different simple policy rules in the euro area economy. Second, it studies the performance of a relatively new type of rule, labelled ‘speed limit’ (SL), where the nominal interest rate reacts to the rate of growth in the output gap. The main conclusion of the study is that an SL policy performs remarkably well.

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