June 2021 issue contents
What Does "Below, but Close to, 2 Percent" Mean? Assessing the ECB's Reaction Function with Real-Time Data

Maritta Paloviita, Markus Haavio, Pirkka Jalasjoki, and Juha Kilponen
Bank of Finland


Using unique real-time quarterly macroeconomic projections of the Eurosystem/ECB staff, we estimate competing specifications of the ECB's monetary policy reaction function. We consider specifications which include inflation and output growth projections, a past inflation gap, a time-varying natural real interest rate, and different inflation targets. Our first key finding is that the de facto inflation target of the ECB lies between 1.6 percent and 1.8 percent. Our second key finding is that the ECB reacts both to short-term macroeconomic projections and to past deviations of inflation from its de facto target.

JEL Code: E31, E52, E58.

Full article (PDF, 45 pages, 2.5 mb)