This paper analyses the behaviour of the European Central Bank over the period 1999–2014 through the estimation of monetary policy reaction functions with time-varying coefficients and heteroskedastic error terms. This allows to evaluate whether relevant shifts in the conduct of monetary policy occurred and whether the current financial crisis had an influence on that. The paper considers two different specifications, one with contemporaneous regressors and one with regressors from surveys. The Taylor rule is then enriched with a set of macroeconomic and financial variables with the aim of testing their significance. Results show that forward-looking variables have a better explanatory power over interest rate policy. All the coefficients are found to be stable along the sample so that no shift in the reaction function can be identified and the financial crisis is found to only lead to a change in the size of the shock. Finally, we also provide evidence about the fact that the ECB has been actually constrained by the zero lower bound during the recent crisis.
- Monetary policy reaction function
- Time-varying parameters