Working Paper: NBER ID: w14190
Authors: Jean Boivin; Marc P. Giannoni; Benoît Mojon
Abstract: This paper characterizes the transmission mechanism of monetary shocks across countries of the euro area, documents how this mechanism has changed with the introduction of the euro, and explores some potential explanations. The factor-augmented VAR (FAVAR) framework used is sufficiently rich to jointly model the euro area dynamics while permitting the transmission of shocks to be different across countries. We find important heterogeneity across countries in the effect of monetary shocks before the launch of the euro. In particular, we find that German interest-rate shocks triggered stronger responses of interest rates and consumption in some countries such as Italy and Spain than in Germany itself. According to our estimates, the creation of the euro has contributed 1) to a greater homogeneity of the transmission mechanism across countries, and 2) to an overall reduction in the effects of monetary shocks. Using a structural open-economy model, we argue that the combination of a change in the policy reaction function -- mainly toward a more aggressive response to inflation and output -- and the elimination of an exchange-rate risk can explain the evolution of the monetary transmission mechanism observed empirically.
Keywords: Monetary Policy; Euro Area; Transmission Mechanism; FAVAR
JEL Codes: C3; D2; E3; E4; E5; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| German interest rate shocks (E43) | stronger responses in interest rates and consumption in countries like Italy and Spain (E49) |
| shift in the European Central Bank's policy reaction function (E52) | more aggressive response to inflation and output (E63) |
| elimination of exchange rate risk (F31) | changes in monetary transmission mechanism (E52) |
| short-term interest rate shocks (E43) | less response in long-term interest rates, consumption, investment, output, and employment (E49) |
| short-term interest rate shocks (E43) | stronger responses in trade and effective real exchange rate (F31) |
| common interest rate shocks (E43) | persistent asymmetries in national monetary aggregates' responses (E19) |
| introduction of the euro (F36) | greater homogeneity in the monetary transmission mechanism (E19) |
| introduction of the euro (F36) | reduction in the effects of monetary shocks (E39) |
| creation of the euro (F36) | increased uniformity in the transmission of monetary policy across the euro area (E52) |
| creation of the euro (F36) | decrease in the magnitude of responses to monetary shocks (E39) |