How the ECB and US Fed set interest rates

Monetary policies of the ECB and US Fed can be characterised by “Taylor rules”, that is bothcentral banks seem to be setting rates by taking into account the “output gap” and inflation.We also set up and tested Taylor rules which incorporate money growth and the euro-dollarexchange rate, thereby improving the “fit” between actual and Taylor rule based rates. In general,Taylor rules appear to be a much better way of describing Fed policy than ECB policy.Simulations suggest that the ECB’s short-term interest rates have been at a much lower levelin the last two years compared with what a Taylor rule would suggest.