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Title:Modifying Taylor reaction functions in presence of the zero-lower-bound: Evidence for the ECB and the Fed PDF Logo
Authors:Belke, Ansgar
Klose, Jens
Issue Date:2012
Series/Report no.:Discussion Papers, German Institute for Economic Research, DIW Berlin 1218
Abstract:We propose an alternative way of estimating Taylor reaction functions if the zero-lowerbound on nominal interest rates is binding. This approach relies on tackling the real rather than the nominal interest rate. So if the nominal rate is (close to) zero central banks can influence the inflation expectations via quantitative easing. The unobservable inflation expectations are estimated with a state-space model that additionally generates a timevarying series for the equilibrium real interest rate and the potential output - both needed for estimations of Taylor reaction functions. We test our approach for the ECB and the Fed within the recent crisis. We add other explanatory variables to this modified Taylor reaction function and show that there are substantial differences between the estimated reaction coefficients in the pre- and crisis era for both central banks. While the central banks on both sides of the Atlantic act less inertially, put a smaller weight on the inflation gap, money growth and the risk spread, the response to asset price inflation becomes more pronounced during the crisis. However, the central banks diverge in their response to the output gap and credit growth.
Subjects:zero-lower-bound
Federal Reserve
European Central Bank
equilibrium real interest rate
Taylor rule
JEL:E43
E52
E58
Document Type:Working Paper
Appears in Collections:Publikationen von Forscherinnen und Forschern des DIW
DIW-Diskussionspapiere

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