Working Paper: NBER ID: w13521
Authors: Lawrence Christiano; Roberto Motto; Massimo Rostagno
Abstract: The US Federal Reserve cut interest rates more vigorously in the recent recession than the European Central Bank did. By comparison with the Fed, the ECB followed a more measured course of action. We use an estimated dynamic general equilibrium model with financial frictions to show that comparisons based on such simple metrics as the variance of policy rates are misleading. We find that - because there is greater inertia in the ECB's policy rule - the ECB's policy actions actually had a greater stabilizing effect than did those of the Fed. As a consequence, a potentially severe recession turned out to be only a slowdown, and inflation never departed from levels consistent with the ECB's quantitative definition of price stability. Other factors that account for the different economic outcomes in the Euro Area and US include differences in shocks and differences in the degree of wage and price flexibility.
Keywords: Monetary Policy; Euro Area; US Economy; Financial Frictions
JEL Codes: C51; E47; E52; E58; F00
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ECB policy actions (E52) | stabilizing effect on output (E63) |
| Fed's aggressive interest rate cuts (E52) | milder economic slowdown in euro area (E66) |
| ECB's supportive monetary policy shocks (E52) | substantial recession not occurring in euro area (E66) |
| US recession-inducing shocks (F44) | quicker Fed response with aggressive monetary policy actions (E52) |
| difference in wage and price flexibility (J31) | different inflation outcomes (E31) |
| same wage and price flexibility as US (F16) | more volatile inflation in euro area (E31) |
| adopting Fed's monetary policy rules (E52) | higher inflation in euro area (E31) |
| adopting Fed's monetary policy rules (E52) | lower output in euro area (E66) |