Working Paper: CEPR ID: DP8472
Authors: Stefan Gerlach; John Lewis
Abstract: We study ECB?s interest rate setting in 1999-2010 using a reaction function in which forecasts of future economic growth and inflation enter as regressors. Allowing for a gradual switch between two reaction functions, we detect a shift after Lehman Brothers failed in September 2008 when the pre-crisis reaction function first indicates that interest rates may become constrained by the zero lower bound. Furthermore, the interest rate cuts in late 2008 were more aggressive than forecast by the pre-crisis reaction function. These findings are compatible with the literature on optimal monetary policy in the presence of a zero lower bound.
Keywords: ECB reaction functions; smooth transition; zero lower bound
JEL Codes: C2; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Lehman Brothers failure (F65) | ECB's reaction function shift (E52) |
| ZLB constraint (E62) | estimated target interest rate falling below zero (E43) |
| ZLB (E62) | monetary policy efficacy (E52) |
| post-crisis economic forecasts (F37) | ECB's responses became more pronounced (E58) |
| pre-crisis estimates (H12) | predicted negative interest rate during the crisis (E43) |
| speed of rate adjustments pre-crisis vs post-crisis (G21) | differences in ECB behavior (E58) |