The relevance of the Taylor rule for the ECB’s policy in an era of unconventional crises and responses

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School of Business | Bachelor's thesis
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Date

2025

Department

Taloustieteen laitos

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Mcode

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Taloustiede

Language

en

Pages

30 + 13

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Abstract

The Taylor rule is a simple description of how central banks set interest rates in response to output fluctuations and to deviations of inflation from its desired rate. The rule emerged during a debate between rules-based and discretionary monetary policy, and it explained very well the interest rate decisions of the Federal Reserve (the Fed) during the early Greenspan years (1987 to 1997). In this thesis, I look into the relevance of the Taylor rule in analyzing the monetary policy of the European Central Bank (the ECB). I review relevant theoretical and empirical literature, and analyze ECB data. The ECB’s single mandate differs from the Fed’s dual mandate, and until recently, the ECB has had an asymmetric inflation targeting rule. The eurozone consists of several countries with varying inflation and different economic cycles. Furthermore, during its operations, the ECB has witnessed extraordinary shocks. The years with negative interest rates and massive quantitative easing are not very compatible with the Taylor rule. However, the use of a shadow rate would allow the use of Taylor rule even during times of unconventional monetary policy. The Taylor rule has its limitations, but the use of ex post data and its mathematically simple model lead to transparency, which has advantages when seeking to understand and communicate monetary policy.

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Thesis advisor

Kitti, Mitri

Keywords

Taylor rule, monetary policy, European Central Bank, eurozone, policy rates, inflation, interest rates, zero lower bound

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https://urn.fi/URN:NBN:fi:aalto-202510268571

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[kand] Kauppakorkeakoulu / BIZ (Open Access)