An Empirical Assessment of Optimal Monetary Policy Delegation in the Euro Area

Xiaoshan Chen, Tatiana Kirsanova and Campbell Leith

No 2014-11, Stirling Economics Discussion Papers from University of Stirling, Division of Economics

Abstract: We estimate a New Keynesian DSGE model for the Euro area under alternative descriptions of monetary policy (discretion, commitment or a simple rule) after allowing for Markov switching in policy maker preferences and shock volatilities. This reveals that there have been several changes in Euro area policy making, with a strengthening of the anti-inflation stance in the early years of the ERM, which was then lost around the time of German reunification and only recovered following the turnoil in the ERM in 1992. The ECB does not appear to have been as conservative as aggregate Euro-area policy was under Bundesbank leadership, and its response to the financial crisis has been muted. The estimates also suggest that the most appropriate description of policy is that of discretion, with no evidence of commitment in the Euro-area. As a result although both ‘good luck' and ‘good policy' played a role in the moderation of inflation and output volatility in the Euro-area, the welfare gains would have been substantially higher had policy makers been able to commit. We consider a range of delegation schemes as devices to improve upon the discretionary outcome, and conclude that price level targeting would have achieved welfare levels close to those attained under commitment, even after accounting for the existence of the Zero Lower Bound on nominal interest rates.

Keywords: Great Recession; Financial Crisis; Zero Lower Bound; Discretion; Commitment; Great Moderation; Optimal Monetary Policy; Interest Rate Rules; Bayesian Estimation (search for similar items in EconPapers)
Date: 2014-11
New Economics Papers: this item is included in nep-cba, nep-dge, nep-eec, nep-mac and nep-mon
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Citations: View citations in EconPapers (13)

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http://hdl.handle.net/1893/21257

Related works:
Working Paper: An Empirical Assessment of Optimal Monetary Policy Delegation in the Euro Area (2014)
Working Paper: An Empirical Assessment of Optimal Monetary Policy Delegation in the Euro Area (2014)
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