economics, euro, eurozone, federal funds rate, germany, greece, greg mankiw, ireland, macroeconomics, mankiw, mankiw rule, milton friedman, monetarism, monetary policy, money supply, portugal, spain, taylor rule
The lack of independent monetary policy within the Eurozone is one of the more economically destructive aspects of the system. Every individual nation in the 17-member grouping is forced to adopt a common monetary policy; even while they all continue to function as sovereign nations otherwise. The result is that money supply in each individual nation cannot be adjusted for the observed market conditions. In my view, this is the Euro’s biggest flaw.
As a little experiment, I wanted to try to determine what sort of monetary policy the Eurozone nations should be running right now. I’ve decided to take the Mankiw Rule in order to try to predict what the short-term interest rates should be in each individual nation.
Background on Mankiw Rule
The two rules are fairly similar in terms of results, but the inputs are slightly different. The Taylor Rule emphasizes the output/inflationary gap and uses raw CPI in order to calculate an optimal Federal funds rate. The Mankiw Rule, on the other hand, uses core CPI, which is CPI excluding food and energy. Mankiw also factors unemployment into the equation. The formula for the Mankiw Rule is below:
Federal funds rate = 8.5 + 1.4 (Core inflation – Unemployment)
I’ve decided to use the Mankiw Rule, not because I have an overwhelming preference for one rule over the other, but because Mankiw will be easier to calculate with the data I can acquire quickly. While there will be minor differences between the two rules, we’re not focusing on precision here, so much as direction and degree.
With that, let’s jump to the results. I will deal with some of the flaws with this methodology afterwards.