On the robustness of the "Taylor Rule" in the EMU A few remarks on convergence

Following a policy rule mechanically when operating monetary policy is neither realistic nor practical. Nevertheless, monetary policy rules have received a great deal of attention in recent macroeconomic research. The paper focuses on a famous interest rate rule, namely the Taylor Rule, to show that the rule parameters are robust to most of the output gap measures and the specifications considered, in the sense that the inflation coefficient is above unity and the output gap coefficient is positive. The estimated rule is shown to track the actual policy performance during the EMU period remarkably well. In addition, the estimated rule is used as an indicator of macroeconomic convergence in the union and it is demonstrated that the optimal EMU rate has not been in accordance with domestic conditions in certain countries. For these countries, Spain, Ireland and the Netherlands, the domestic interest rate rule is estimated to explore the resemblance of the parameters. JEL-classification: E58; F41 ∗European University Institute, Economics Department, Villa San Paolo, Via della Piazzuola 43, 50133 Florence, Italy. Email: [email protected]. The first version of this paper was submitted in December 2002 to the Economics Department of the European University Institute, as part of the requirements for the doctoral programme.