Monetary Policy Rules in a New Keynesian Euro Area Model

Authors


  • The first version of this paper was written while the author took part in the “Convocatoria para la realización de trabajos sobre economía en el Banco de España, 2003–2004.” The author thanks Javier Vallés, Javier Andrés, Jordi Galí, David López-Salido, Óscar Bajo-Rubio, and Bennett T. McCallum for helpful comments and suggestions, and both Banco de España and Ministerio de Educación y Ciencia (research projects 2002/00954 and SEJ2005-03470/ECON) for their financial support. The opinions expressed in this paper are exclusively of the author and do not necessarily reflect those of Banco de España.

Abstract

The first part of this paper is devoted to describe a New Keynesian model, which, after calibration, shows a great fit on Euro area macroeconomic data. Then, the stabilizing properties of alternative monetary policy rules are evaluated for consideration of the European Central Bank (ECB). Our main finding is that a simple rule that provides the reaction of the nominal interest rate to price inflation, wage inflation, and its previous observation can fairly well approximate the optimal monetary policy. This result is robust to including an ECB preference on interest-rate smoothing.

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