How the European Central Bank decided its early monetary policy

Abstract

The main goal in this paper is to detect the mechanisms that should rationally stimulate the decision making-policies of the European Central Bank. This is carried out under the framework of theoretical principles of interest rate rules. Firstly, we deduce a set of logically advisable guidelines for the strategy actually developed by this central bank. Then, we contrast a wide set of hypotheses with reference to those variables the ECB take into account on deciding its monetary policy, with a flexible treatment regarding the number of months of advance or delay in the explanatory variables. The results lead us to the conclusion that the ECB, besides adopting a smooth strategy, especially bears in mind the expected core inflation rate, with a reaction coefficient adjusted to that initially proposed by Taylor. The economic growth rate, though it has a significant positive coefficient, matters relatively little and is backward looking. Finally, we evaluate up to what point the behavior of the ECB is assimilative to an inflation targeting framework, solving this question affirmatively.