Milas, Costas2010-04-062010-04-062009-10Milas, C & Naraidoo, R 2009, 'Financial market conditions, real time, nonlinearity and European Central Bank monetary policy: in-sample and out-of-sample assessment', University of Pretoria, Department of Economics, Working paper series, no. 2009-23. [http://web.up.ac.za/default.asp?ipkCategoryID=736&sub=1&parentid=677&subid=729&ipklookid=3]http://hdl.handle.net/2263/13776We explore how the ECB sets interest rates in the context of policy reaction functions. Using both real-time and revised information, we consider linear and nonlinear policy functions in inflation, output and a measure of financial conditions. We find that amongst Taylor rule models, linear and nonlinear models are empirically indistinguishable within sample and that model specifications with real-time data provide the best description of in-sample ECB interest rate setting behavior. The 2007-2009 financial crisis witnesses a shift from inflation targeting to output stabilisation and a shift, from an asymmetric policy response to financial conditions at high inflation rates, to a more symmetric response irrespectively of the state of inflation. Finally, without imposing an a priori choice of parametric functional form, semiparametric models forecast out-of-sample better than linear and nonlinear Taylor rule models.enUniversity of Pretoria, Department of EconomicsNonlinearity (Mathematics)Real time dataFinancial conditions indexEuropean Central Bank (ECB)Monetary policy -- Mathematical modelsNonlinear theoriesInterest ratesTaylor's ruleWorking Paper