- In today’s Comment we will try to make sense of market pricing for ECB rates by using simple models or rules of thumb to get a sense of where policy rates should be in the present and in (near) future. Now, a disclaimer first. The models/rules of thumb all hark back to the famous Taylor rule, which is an equation that states that the central bank overnight rate is a function of (core) inflation relative to target; output relative to its potential; plus the estimate of the neutral rate of interest. Both the neutral rate of interest and potential GDP are unobservable variables. Organizations with binders full of econ Phds – think the EU Commission, the IMF and the OECD, try to estimate potential GDP growth using complex econometric models. When such organizations are involved, estimates are inherently political (besides the estimates being very uncertain in the first place).
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