THE RELEVANCE OF REAL-TIME DATA IN ESTIMATING REACTION FUNCTIONS FOR THE EURO AREA

This paper tackles the issue of the incompleteness of information available to thecentral bank when taking its monetary policy decisions. It is focused on euro areadata and based on the simplistic assumption of the central bank following a simplemonetary policy rule à-la-Taylor. Along the lines of the work by Orphanides (2001),our aim is to assess whether estimates of reaction functions which are carried outusing revised data for the euro area can be misleading. In essence, the analysisyields indications which are consistent with the findings by Orphanides for theUnited States. First of all, the results found suggest that it would be preferable fora central bank not to attach too much weight on output gap measures in policyanalysis, given that such measures are subject to large revisions over time. Moreover,the coefficients of a simple Taylor rule estimated in real time differ quite considerablyfrom those related to the same rule estimated on the basis of ex postrevised data. More precisely, a coefficient for inflation larger than one (which is arequirement for a unique equilibrium in many theoretical models) in real time isfound only in case a forward-looking specification based on the Survey of ProfessionalForecasters is used. On the contrary, when using revised data, the sameresult is obtained if the Taylor rules include the current inflation rate. This showshow a misleading inference can occur when the appropriate available data are nottaken into account.