Monetary Policy Rules and Directions of Causality: a Test for the Euro Area

Use is made of a VAR model in first differences with quarterly data for the Eurozone to ascertain whether decisions on monetary policy can be interpreted in terms of a “monetary policy rule”, with specific reference to the so-called “nominal GDP targeting rule” (McCallum 1988; Hall and Mankiw 1994; Woodford 2012). The results obtained indicate a causal relation proceeding from deviation between the growth rates of nominal GDP and target GDP to variation in the three-month market interest rate. The same analyses do not, however, appear to confirm the existence of a significant inverse causal relation from variation in the market interest rate to deviation between the nominal and target GDP growth rates. Similar results were obtained on replacing the market interest rate with the ECB refinancing interest rate. This confirmation of only one of the two directions of causality does not support an interpretation of monetary policy based on the nominal GDP targeting rule and gives rise to doubt in more general terms as to the applicability of the Taylor rule and all the conventional rules of monetary policy to the case in question. The results appear instead to be more in line with other possible approaches, such as those based on Post-Keynesian analyses of monetary theory and policy and more specifically the so-called “solvency rule” (Brancaccio and Fontana 2013, 2015). These lines of research challenge the simplistic argument that the scope of monetary policy consists in the stabilization of inflation, real GDP or nominal income around a “natural equilibrium” level. Rather, they suggest that central banks actually follow a more complex purpose, which is the political regulation of financial system with particular reference to the relations between creditors and debtors and the related solvency of economic units.