One money and sixteen needs: has the ECB's monetary policy become more balanced towards the needs of the member states?
Faculty of Applied Economics
De economist. - Haarlem
, p. 43-60
University of Antwerp
In this paper we analyze whether the ECBs monetary policy has become more balanced towards the needs of the individual member states with the passage of time. We assume that the ECBs monetary policy stance is in line with a Taylor rule and based on the overall situation in the Euro area, more specifically on the Euro area inflation rate and the overall business cycle position in the area. The question therefore boils down to investigating whether inflation and business cycles have converged since the start of the monetary union. We show that the ECB, if in existence in the 1990s, would have had an impossible task. This is because inflation and business cycles still strongly differed in that time, although convergence substantially increased in the run up to the monetary union. In this respect, the decade under EMU drastically differs from the preceding one. This being said, the evidence for a further improvement in the course of the first decade of the new millennium is mixed. This is because although inflation has further converged, business cycles have shown a tendency for increased divergence. If, however, we are willing to put weights on inflation and output gap divergence (as implied by the Taylor rule), we conclude that also in the course of the period under EMU in general the ECBs monetary policy has become more in line with the needs of the individual members. Looking at individual countries, we show that during the first decade of its existence the ECBs interest rate was most fitted to the needs of France and Italy, and least to the needs of Ireland and Greece (both too low) and Germany (too high). To a lesser extent there were also mismatches for Spain and Portugal (both too low). In the more recent period since 2005, the mismatch between the desired domestic interest rate and the desired ECB rate has come down for most countries (most noticeable Germany). For Belgium (for which a higher interest rate was more appropriate), on the other hand, the mismatch increased. These overall positive findings, however, offer no guarantee that the task of the ECB will become easier in the future