Analysing monetary policy transmission at the euro area level using structural macroeconomic models

Abstract

Introduction This chapter examines the monetary policy transmission mechanism at the euro area level using macroeconomic models and considers some of the issues raised by such an undertaking. The aim is to assess how important various aspects of model and simulation design are in determining the results. To illustrate the importance of these issues, we report results using the ECB's Area Wide Model (AWM) and the National Institute Global Economic Model (NiGEM). The AWM is a single-country model of the euro area using aggregated euro area data – a full description of the model is provided by Fagan, Henry and Mestre (2001). There is no country disaggregation so the AWM treats EMU members as one country. NiGEM, by contrast, models each individual country separately and the euro area results that we report are based on a static aggregation of individual country results (NIESR, 2001). Nevertheless, it is possible to run the model consistent with a monetary union in the euro area and thereby ensure common interest rate and exchange rate paths for countries within the euro area. The chapter takes as its starting point the last major study of comparative properties of central bank models (BIS, 1995). The BIS study examined cross-country differences in the transmission mechanism of monetary policy and considered the extent to which these could be due to differences in financial structure. Simulation experiments were undertaken on the models involving a 100-basis point increase in the short-term policy interest rate for two years.