Over the past years, there is a marked improvement in the macroeconomic performance of the industrialized and developing countries. Both the level and variability of inflation were lower in the latter half of the 1990s than they were in the preceding ten years. In a broad cross-section of 63 countries, median inflation dropped from 7.04% in 1985:I-1994:IV to 2.97% in 1995:1-1999:IV. The decrease in average inflation has been even sharper, falling from 83.19% to 8.59%. Inflation rose in only 10 of the 63 countries examined, and in most of those, the increase was small—only in Ghana, Indonesia and Turkey did the average inflation rise by more than 2 percentage points. Better macroeconomic performance means more than just lower inflation: it involves more stable inflation and real growth. Improved macroeconomic outcome can arise due to several factors. One possibility is that the world has become a more stable place. If there are no shocks hitting an economy, it will surely be more stable. Alternatively, monetary policy makers may have become more skillful at implementing policies to meet their stabilization objectives.

This paper intends to develop a method for measuring the contribution of an improved monetary policy to the observed changes in macroeconomic performance. Specifically, we look at the changes in the variability of inflation and output for the 14 countries of the European Union (excluding Luxemburg, which did not have an independentmonetary policy during the analyzed period), and compare the 1980s and the 1990s.1 A simple macroeconomic model of inflation and output for each country specifying the dynamics of inflation and output as a function of the interest rate—the measure of central bank policy in this paper—as well as additional exogenous variables, is estimated. Using the estimated model, the monetary policy rules as a function of the aggregate shocks and the parameters of the economy, for two sample periods, 1983 to 1990 and 1991 to 1998 could be identified. This helps to compute the change in macroeconomic performance for each country using a weighted sum of inflation and output volatility, and examine how much of that change can be accounted for by the changes in the volatility of the aggregate shocks and how much can be ascribed to the improvements in policy efficiency.