Optimal favoritism within ECB policy

This thesis establishes a framework to justify the perceived regional biases within ECB interest rate setting policy. In order to accomplish this, a Taylor-rule is constructed from which five conditions are derived regarding differences in economic circumstances among member states. These economic circumstances consist of: (1) differences in output persistence, (2) interest rate elasticity, (3) sensitivity to real exchange rate changes, (4) exposure to non-Eurozone trade and (5) inflationary pressure of the output-gap. If one of the conditions derived from the Taylor rule is violated, it indicates that it is optimal for the ECB to favor economic circumstances within a member state more than is merited by its economic size alone. To demonstrate how these conditions justify regional biases within ECB policy, the weights of the four largest Eurozone member states are determined for which it holds that the ECB conducts optimal policy. Indeed, it was found that in some cases, the ECB conducts optimal policy if it under- or overweights some member states. However, due to a lack of data points, the constructed model could not be empirically validated. Therefore, the values of the estimated optimal weights are not completely accurate, but merely serve as an indication that it could be optimal for the ECB to under- or overweigh certain member states.