Estimating monetary policy reaction functions: Comparison between the european central bank andswedish central bank

Abstract

This study estimated and compared a forward-looking Taylor-type reaction function between the European Central Bank (ECB) and Swedish Central Bank (Riksbank).First, an estimated baseline model shows that, compared with the ECB, the Riksbank is an aggressor based on its responses to expected inflation and output gap.Second, the estimated baseline model significantly tracks both central banks’ actual interest rates, though with certain deficiencies.Furthermore, this study augments the baseline model by exploring additional variables that appropriately describes the ECB and Riksbank’s monetary policy.We observed that foreign interest rate, notably the federal funds rate, influence the ECB’s monetary policy to a certain degree.Moreover, the ECB’s short-term interest rate and real exchange rate impact the Riksbank’s monetary policy.Although foreign interest rate explains the ECB and Riksbank’s monetary policy, real exchange rate also explains the Riksbank’s monetary policy (small open economy) than that of the ECB.