Modeling the European Central Bank Official Rate: A Stochastic Approach

Maria Francesca CARFORA
Luisa CUTILLO
Albina ORLANDO

Keywords

ECB rates, Markov-switching, Business cycle, Non-homogeneous Poisson process

Abstract

Following its main task of price stability in the euro area, the European Central Bank (ECB) increases or decreases interest rates in order to cool inflation or respectively to support economic growth. Monetary policy shows delayed effects on inflation and thus the ECB modifies interest rates on the basis of forecasts about the state of economy over the coming quarters. Aim of our contribution is to provide a stochastic model for the ECB official rate taking into account the expectations on the future state of economy. We propose a non homogeneous Poisson process to describe the intervention times of the ECB. In particular the jump process parameters depend on the evolution of the economic cycle as modeled by a MS-AR model. We show an application on suitably aggregated European data.