Implications and Relevance
Edited by Phillip Arestis, Michelle Baddeley and John S.L. McCombie
Chapter 4: Monetary policy divergences in the euro area: the early record of the European Central Bank
Georgios Chortareas 1. INTRODUCTION1 This chapter attempts to contribute to our understanding and monitoring of cyclical divergences within the euro area. In particular, we provide some simple analytical tools for assessing the degree of convergence in monetary policy needs in Europe. In contrast to most existing attempts that monitor divergences of real and nominal variables in the euro area, we examine whether the progress towards Economic and Monetary Union (EMU) during the early years of the European Central Bank (ECB) has enhanced convergence in the monetary policy needs of the participating countries or imposed a straitjacket on them. In other words, we focus on divergent policy needs (or warranted policy divergences) rather than divergences of macroeconomic variables. We use simple policy rules as a consistent benchmark to provide a framework for assessing whether the policy needs of EMU participant countries converge. In order to capture any form of divergences we need a benchmark. Such a benchmark would approximate the optimal monetary policy rule that shows how each individual euro area member country would run its monetary policy optimally if it were not a member of a monetary union. Deﬁning ‘optimal monetary policy’ is not an easy task, let alone when one considers more than one country. In this chapter we try to tackle this problem by using Taylor rules as such a consistent benchmark. A Taylor rule is a simple way to describe a monetary policy regime when the interest rate is set in response to inﬂation and...
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