Monetary Policy Rules in a New Keynesian Euro Area Model

Abstract

The first part of this paper is devoted to describe a New Keynesian model, which, after calibration, shows a great fit on Euro area macroeconomic data. Then, the stabilizing properties of alternative monetary policy rules are evaluated for consideration of the European Central Bank (ECB). Our main finding is that a simple rule that provides the reaction of the nominal interest rate to price inflation, wage inflation, and its previous observation can fairly well approximate the optimal monetary policy. This result is robust to including an ECB preference on interest‐rate smoothing.