Jens Klose

(How) do the ECB and the Fed React to Financial Market Uncertainty? The Taylor Rule in Times of Crisis

We assess differences that emerge in Taylor rule estimations for the Fed and the ECB before and after the start of the subprime crisis. For this purpose, we apply an explicit estimate of the equilibrium real interest rate and of potential output in order to account for variations within these variables over time. We argue that measures of money and credit growth, interest rate spreads and asset price infl ation should be added to the classical Taylor rule because these variables are proxies of a change in the equilibrium interest rate and are, thus, also likely to have played a major role in setting policy rates during the crisis. Our empirical results gained from a state-space model and GMM estimations reveal that, as far as the Fed is concerned, the impact of consumer price inflation, and money and credit growth turns negative during the crisis while the sign of the asset price inflation coefficient turns positive. Thus we are able to establish significant differences in the parameters of the reaction functions of the Fed before and after the start of the subprime crisis. In case of the ECB, there is no evidence of a change in signs. Instead, the positive reaction to credit growth, consumer and house price inflation becomes even stronger than before. Moreover we find evidence of a less inertial policy of both the Fed and the ECB during the crisis.

Does the ECB Rely on a Taylor Rule During the Financial Crisis? Comparing Ex-post and Real Time Data with Real Time Forecasts

We assess the differences that emerge in Taylor rule estimations for the ECB when using ex-post data instead of real time forecasts and vice versa. We argue that previous comparative studies in this field risk mixing up two separate effects. First, the differences resulting from the use of ex-post and real time data per se and, second, the differences emerging from the use of non-modified real time data instead of real-time data based forecasted values (and vice versa). Since both effects can influence the ECB reaction to inflation and the output gap either way, we use a more clear-cut approach to disentangle the partial effects. However, “good” forecasts have to be as close as possible to the forecasts the ECB governing council had at hand when taking its interest rate decision. Therefore we use two approaches to generate the forecasts: First, forecasts generated relying on a pure AR process and, second, explicit ECB staff projections which are available only at a quarterly frequency. So we found it indispensable to estimate all variants of the reaction function using also quarterly data. Our estimation results indicate that using real time instead of ex post data leads to higher estimated inflation and output gap coefficients. If real time forecasts are used (since actual data become available with a lag), the output response is reduced while the inflation response depends crucially on the inclusion of an interest rate smoothing term, the data frequency and forecast type.

A simple way to overcome the zero lower bound of interest rates for central banks: Evidence from the Fed and the ECB within the financial crisis

In this paper, we investigate how Fed and ECB monetary policy changed within the financial crisis of 2007-2010. We argue that due to the very low interest rates classical monetary policy rules like, e.g., the Taylor rule could lead to false conclusions. We propose a new way of conducting monetary policy when the zero lower bound becomes binding via shaping the inflation expectations. Our results indicate that using this modified Taylor rule shows similar tendencies in the reaction coefficients as the standard Taylor rule at least if no interest smoothing term is included.

Who gains from nominal devaluation? An empirical assessment of Euro-area exports and imports

In early 2013 rumors about the Euro-appreciation gained momentum, which may lead to decreases in exports and increases in imports of the member states. Therefore, we investigate the impact of changes in the nominal Euro exchange rate vis-a-vis major currencies on export and import performance of nine different Euro-area-countries. To disentangle the true equilibrium elasticities SURE system error correction models (SSECM) are estimated for nominal exchange rate changes versus the rest of the world or other major currencies. To differentiate between price level changes and changes of the nominal exchange rate, a countrys export and import equation is estimated using separately the nominal rate and the relative price/ unit labor cost as regressors. Results of Wald-tests indicate that assuming both variables to have the same influence on exports and imports is misleading. Whether the relative price/ unit labor costs elasticities are high or low depends crucially on which indicator is chosen, while the effect of nominal exchange rate changes can be estimated robustly for all countries in the sample. Especially France and Spain are hit by a Euro appreciation since their exports are highly exchange rate elastic. However, for France, this effect is at least partly offset by an also negative exchange rate elasticity of imports.

Political Business Cycles and Monetary Policy Revisited – An Application of a Two-Dimensional Asymmetric Taylor Reaction Function

This paper uses two-dimensional asymmetric Taylor reaction functions for 16 OECD-countries to account for different reactions to the inflation rate and output by central banks before or after an election of the fiscal authorities in the respective country. Important for such an investigation is not only the period before or after an election takes place but also whether the inflation rate and output are below or above their target or potential value because this information shows whether the central bank systematically deviates from the Taylor rule. Using a Panel-GMM we observe that in the OECD-countries there are political business cycles in monetary policy with respect to the inflation and output response. However, the supporting time horizon differs between both exogenous indicators and state of variables.

Implicit Taylor reaction functions for Euro area countries

This study estimates modified Taylor reaction functions which tackle the real rather than the nominal interest rates for the Euro area as a whole, and separately for the individual member states, before the onset of the current sovereign debt crisis. We show there are significant differences between Taylor reaction functions in the Euro area countries, which cast doubts on the Euro area being an optimal currency area. The results are used to carry out out-of-sample forecasts for the sovereign debt crisis period which show that the ECB has held the interest rate low for most of the countries during the crisis.

Optimale Geld- und Fiskalpolitik unter Unsicherheit

Die internationale Finanzund Wirtschaftskrise hat in vielen Ländern zu einer Renaissance der Stabilisierungspolitik geführt. Sowohl die Geldwie auch die Fiskalpolitik wurden in sehr starkem Umfang eingesetzt, um die Auswirkungen des weltweiten Nachfrageeinbruchs abzufedern. Dabei war die Unsicherheit über die Wirkungen dieser Maßnahmen selten so groß wie in jüngerer Zeit. Der Ansatz von Brainard (1967) liefert eine anschauliche Analyse der Implikationen dieser speziellen Form von Unsicherheit für die optimale Ausgestaltung der Stabilisierungspolitik. Es wird gezeigt, dass demnach die Stabilisierungspolitik im Regelfall umso zurückhaltender und vorsichtiger agieren sollte, je größer die Unsicherheit über die Wirksamkeit der Instrumente (Multiplikatoren) ist. Neuere Beiträge kommen teilweise zu entgegengesetzten Ergebnissen.