Working paper no. 96: Testing optimal monetary policy in a currency union
The Central Bank of Iceland has published the working paper "Testing Optimal Monetary Policy in a Currency Union" by Bjarni G. Einarsson, economist in the department of Economics and Monetary Policy
The paper presents a framework for testing the optimality of monetary policy decisions made by a central bank in a monetary union. Applying the framework to test the European Central Banks monetary policy decisions the paper documents several instances of optimization failures in its use of the Forward Guidance and Quantitative Easing instruments. Optimality in the ECB‘s use of the Target Rate instrument cannot be rejected. The paper documents signs of heterogeneity in the optimal prescriptions for the individual member countries with respect to the union level prescription. Additionally, many instances of optimization failure at the country level are found for all instruments. Assuming each country has a country specific version of the union loss function a measure is provided of the cost of abandoning independent monetary policy by joining a union. The results indicate that the price of Euro membership is higher for the peripheral economies.
The working paper can be accessed here: Testing optimal monetary policy in a currency union