A Taylor Rule for the Euro Area?

Sammanfattning: The purpose of this paper is to examine whether the original Taylor rule can be used to describe the monetary policy set by the European Central Bank (ECB), when using aggregated inputs for inflation and output gap from the whole euro area as well as for specific regions. If the original Taylor rule is not applicable to the monetary policy of the ECB, we aim to develop a new Taylor rule equation specially adapted for the euro area and the ECB, based on their monetary policy set 1999-2016. The methodology used is to compute the interest rate implied by the original Taylor rule and regress it on the actual interest rate set by the ECB. The conclusion is that the monetary policy of the ECB does not follow the original Taylor rule. The original Taylor rule is not applicable to the monetary policy of the ECB when breaking down the euro area into different regions either. Therefore a new Taylor rule better suitable for the euro area is developed. The new formula puts more weight on the output gap than the deviation from the inflation target, as opposed to the original Taylor rule where there are equal weights on the two variables. The new Taylor rule is shown to be applicable for almost all regions in the euro area.