Interest-Rate Setting at the ECB Following the Financial and Sovereign Debt Crises, in Real-Time

Florence Bouvet, Sharmila King

.

DOI: 10.4236/me.2011.25083                

Abstract

We analyse European Central Bank (ECB) policy by estimating a forward-looking, augmented Taylor rule using expectations data. Specifically, we investigate the impact of the financial and sovereign debt crises on ECB policy. We find the European Overnight Index Average (EONIA) rises when expected economic activity is strong. Regardless of the inflation measure, inflation is not associated with the EONIA. Using a recursive estimation and a Chow test, we identify a policy shift in December 2008. The more generally accepted starting date of the crisis, August 2007, does not correspond to a statistically significant shift in the ECB policy. Using December 2008 for a policy shift, general financial market sentiment, as measured by VSTOXX, is not significant in explaining EONIA movements. The ECB’s response to a shock to economic activity has been more moderate since the crises. However, the EONIA increases as Greek sovereign risk rises, possibly from increasing demand for liquidity by banks.

Keywords

Taylor Rule, EONIA, ECB, Financial Crisis, Sovereign Debt Crisis

Conflicts of Interest

The authors declare no conflicts of interest.

References

[1]	J. C. Trichet, “State of the Union: The Financial Crisis and the ECB’s Response between 2007 and 2009,” Journal of Common Market Studies, Vol. 48, 2010, pp. 7-19.
[2]	ECB, “The Outcome of the ECB’s Evaluation of Monetary Policy Strategy,” ECB Monthly Bulletin, June 2003. www.ecb.int.
[3]	S. Sauer and J.-E. Sturm, “Using Taylor Rules to Understand ECB Monetary Policy,” CES-IFO Working Paper No. 1110, 2003.
[4]	R. Fendel and M. Frenkel, “Taking the European Central Bank to the Data,” Zeitschrift Für Wirtschaftspolitik, Vol. 54, No. 1, 2005, pp. 101-114.
[5]	D. Gerdesmeier and B. Roffia, “Estimates of Reaction Functions for the Euro Area,” ECB Working Papers, No. 206, January 2003.
[6]	J. Gorter, J. Jacobs, and J. de Haan, “Taylor Rules for the ECB Using Expectations Data,” Scandinavian Journal of Economics, Vol. 110, No. 3, 2008, pp. 473-488. doi:10.1111/j.1467-9442.2008.00547.x
[7]	J. Gorter, F. Stolwijk, J. Jacobs and J. de Haan, “ECB Policy Making and the Financial Crisis,” DNB Working Paper, No. 272, 2010.
[8]	J. Taylor, “Discretion versus Policy Rules in Practice,” Carnegie-Rochester Conference Series on Public Policy, Vol. 39, 1993, pp. 195-214. doi:10.1016/0167-2231(93)90009-L
[9]	S. Gerlach, “Interest Rate Setting by the ECB 1999-2006: Words and Deeds,” International Journal of Central Banking, Vol. 3, No. 3, 2007, pp. 1-45.
[10]	A. Orphanides, “Monetary Policy Rules Based on Real- time Data,” American Economic Review, Vol. 91, No. 4, 2001, pp. 964-985. doi:10.1257/aer.91.4.964
[11]	G. Rudebusch, “Term Structure Evidence on Interest Rate Smoothing and Monetary Policy Inertia,” Journal of Monetary Economics, Vol. 49, No. 6, 2002, pp. 1161- 1187. doi:10.1016/S0304-3932(02)00149-6
[12]	R. Clarida, J. Gali and M. Gertler, “Monetary Policy Rules in Practice: Some International Evidence,” European Economic Review, Vol. 42, No. 6, December 1998, pp. 1033-1067. doi:10.1016/S0014-2921(98)00016-6
[13]	J. Faust, J. Rogers and J. Wright, “An Empirical Comparison of Bundesbank and ECB Monetary Policy Rules,” International Finance Discussion Papers, No. 705, Board of Governors of the Federal Reserve System, 2001.
[14]	D. Gerdesmeier and B. Roffia, “The Relevance of Real- Time Data in Estimating Reaction Functions for the Euro Area,” HfB-Business School of Finance and Management Working Papers, No. 56, June 2004.
[15]	S. Gerlach, “ECB Repo Rate Setting during the Financial Crisis,” Institute for Monetary and Financial Stability and CEPR Working Paper, 2010.
[16]	K. Carstensen, “Estimating the ECB Policy Reaction Function,” German Economic Review, Vol. 7, No. 1, 2006, pp. 1-34. doi:10.1111/j.1468-0475.2006.00145.x
[17]	A. Belke and J. Klose, “(How) Do the ECB and the Fed React to Financial Market Uncertainty? The Taylor Rule in Times of Crisis,” University of Duisburg-Essen Working Paper, 2010.
[18]	E. Castelnuovo, “Taylor Rules and Interest Rate Smooth- ing in the Euro Area,” 2005.
[19]	C. F. Baum, M. E. Schaffer and S. Stillman, “Ivreg2: Stata Module for Extended Instrumental Variables/2SLS, GMM and AC/HAC, LIML and k-Class Regression,” 2007. http://ideas. repec.org/c/boc/bocode/s425401.html
[20]	T. Linzert and S. Schmidt, “What Explains the Spread Between the Euro Overnight Rate and the ECB’s Policy Rate,” ECB Working Paper Series, No. 983, December 2008.
[21]	J. Beirne, “The EONIA Spread Before and during the Crisis of 2007 to 2009: The Role of Liquidity and Credit Risk,” August 2010. https://editorialexpress.com/cgi-bin/conference/download.cgi?db_name=res2011&paper_id=60, 2010.
[22]	D. Giannone, J. Henry, M. Lalik and M. Modugno, “An Area-Wide Real-Time Database for the Euro Area,” ECB Working Papers Series, No. 1145, January 2010. www.ecb.int
[23]	A. Orphanides and S. van Norden, “The Unreliability of Output Gap Estimates in Real-Time,” Review of Economics and Statistics, Vol. 84, No. 4, November 2002, pp. 569-583. doi:10.1162/003465302760556422
[24]	A. Orphanides and S. van Norden, “The Reliability of Inflation Forecasts Based on Output Gap Estimates in Real-Time,” CEPR Discussion Papers Series, No. 4830, 2005. www.cepr.org/pubs/dps/DP48- 30.asp
[25]	F. Heinemann and F. P. Huefner, “Is the View from the Eurotower purely European? National Divergence and ECB Interest Rate Policy,” Scottish Journal of Political Economy, Vol. 51, No. 4, 2004, pp. 544-558. doi:10.1111/j.0036-9292.2004.00320.x
[26]	P. Rousseau and P. Watchel, “Inflation Thresholds and the Finance-Growth Nexus,” Journal of International Money and Finance, Vol. 21, No. 6, 2002, pp. 777-793. doi:10.1016/S0261-5606(02)00022-0
[27]	J. Aizenman and R. Glick. “Sterilization, Monetary Policy, and Global Financial Integration,” Review of International Economics, Vol. 17, No. 4, 2009, pp. 777-801. doi:10.1111/j.1467-9396.2009.00848.x
[28]	E. S. Knotek, “How Useful is Okun’s Law?” Federal Reserve Bank of Kansas City Economic Review, 4th Quarter 2007.
[29]	A. Four?ans and R. Vranceanu, “The ECB Interest Rate under the Duisenberg Presidency,” European Journal of Political Economy, Vol. 20, No. 3, 2004, pp. 579-595. doi:10.1016/j.ejpoleco.2004.01.003
[30]	A. Schianchi and G. Verga, “A Theoretical Approach to the EONIA Rate Movements,” Working Paper, University of Parma, Parma, 2006.
[31]	C. Soares and P. Rodrigues, “Determinants of the EONIA Spread and the Financial Crisis,” Bank of Portugal Working Paper Series 12/201, 2011.