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Empirical Economics

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01.05.2014

Zero lower bound, ECB interest rate policy and the financial crisis

verfasst von: Stefan Gerlach, John Lewis

Erschienen in: Empirical Economics | Ausgabe 3/2014

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Abstract

We explore whether the ECB’s interest rate setting behaviour changed during the financial crisis by estimating reaction functions over the period 1999–2010, allowing for a smooth transition from one set of parameters to another. The estimates show a swift change in the months following the collapse of Lehman brothers. The ECB appears to have cut rates more aggressively than expected solely on the basis of the worsening of macroeconomic conditions, consistent with the theoretical literature on optimal monetary policy in the vicinity of the zero bound.

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We use the term “zero lower bound” to denote the lower bound regardless of its exact numerical value.

See Ullersma (2002) for a survey of the literature on the ZLB.

Viñals (2001) contains an overview discussion of the consequences of the ZLB. See also Gerlach et al. (2009), Reifschneider and Williams (2000), Viñals (2001), and Coenen et al. (2004).

See Orphanides and Wieland (2000); Svensson (2001) or Coenen and Wieland (2003, 2004).

Adam and Billi (2006) reach a similar conclusion based on the expectations channel using a standard forward-looking New Keynesian model, as do Orphanides and Wieland (2000) using dynamic programming techniques.

To check whether this choice of dependent variable is driving our results, we also re-estimated our model using the repo rate as a dependent variable. This yields results very similar to those reported in the main paper (full results available from the authors on request).

Note that the inclusion a variable in the ECB reaction function does not imply it appears in ECB’s objective function. Svensson (1997) shows that even if the sole objective of policy is to stabilise inflation, the central bank should react to any variable which helps forecast future inflation.

While this approach is similar to that of Mankiw et al. (1987), the STR approach assumes a constant error variance. Estimating the model using their approach yields very similar results and the hypothesis of constant variance is not rejected.

Inflation, money growth and the rate of depreciation are all measured over 12 months.

The switching point is estimated as 225.4 and the time trend takes the value 225 in October and 226 in November. Hence, we refer to the two periods as “pre-crisis” and “crisis.”

The turbulence in the interbank market caused by fears about the millennium bug, and the fact that this effect peaked prior to December 1999 have been documented elsewhere. See for example Bank of England (2000) or Gerlach (2007).

These were tested against a version of the unrestricted model which included the two single-period dummies mentioned above. This intermediate regression is not reported for space reasons.

For full results please, see Table 4 in the Appendix.

Results for different interest rates and inclusion of financial variables are not reported for space reasons.

Thus, in constructing these forecasts we use the actual value of all the regressors, except past values of the interest rate, for which we use forecasted values.

We also estimated a version of the model in which the regime in force depends on the lagged level of the interest rate, but did obtain any useful estimates.

This means we use first release, rather than revised data for GDP. Since data are only available on a quarterly basis, we interpolate to obtain monthly figures.

We abstract from publication lags in this analysis. We assume that the ECB could have nowcast the current quarters GDP with reasonably accuracy. Our results locate the midpoint of the switch when GDP is 2.6 percentage points below trend. This is much larger than the typical forecast errors associated with nowcasts, or 1 quarter ahead GDP forecasts, which tend to be around 0.2 (Angelini et al. 2008).

If our gap measure is included in the pre-crisis reaction function alongside the PMI, the former is insignificant, and the latter remains highly significant.

A likelihood ratio test of these restrictions yields p = 0.967, so the restrictions are accepted

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Titel: Zero lower bound, ECB interest rate policy and the financial crisis
verfasst von: Stefan Gerlach
John Lewis
Publikationsdatum: 01.05.2014
Verlag: Springer Berlin Heidelberg
Erschienen in: Empirical Economics / Ausgabe 3/2014
Print ISSN: 0377-7332
Elektronische ISSN: 1435-8921
DOI: https://doi.org/10.1007/s00181-013-0713-6

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