Interest Rate Setting at the ECB Following the Financial and Sovereign Debt Crises, in Real-Time

Bouvet, Florence. and King, Sharmila (2011) Interest Rate Setting at the ECB Following the Financial and Sovereign Debt Crises, in Real-Time. [Conference Proceedings]

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Abstract

This paper examines European Central Bank (ECB) policy decisions to adjust the repo rate. We estimate a forward-looking, ordered-logit model using real-time and expectations data. In particular, we investigate the impact of the 2007-2009 financial and sovereign debt crises on the ECB interest rate policy. We find that the repo rate is more likely to rise when real economic activity (economic sentiment) is strong, and the ECB's decision to increase the repo rate is not affected by inflation forecasts. We find the ECB responds to an increasing sovereign risk premium by lowering the repo rate. In addition, we examine whether the change in ECB Presidency from Willem Duisenberg to Jean-Claude Trichet and the recent financial crisis induced a policy shift. We do not find a regime switch from the Duisenberg presidency to Trichet presidency, but we find that the financial crisis has reduced the importance of the exchange rate, and also how strongly the ECB reacts to improvements in economic activity.

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