Abstract
ABSTRACT This paper evaluates the macroeconomic effects of the European Central Bank's (ECB) Expanded asset purchase programme (APP) on Latvia and other euro area jurisdictions and investigates the cross-border transmission mechanism. To that end, we employ two different vector autoregressive (VAR) models, namely a bilateral structural VAR with block exogeneity (BSVAR-BE) and a multi-country mixed cross-section global VAR with stochastic volatility (MCS-BGVAR-SV). We find that the APP had a limited and weakly significant impact on Latvia's output while the effect on inflation has been robust due to depreciation of the euro. Regarding other jurisdictions, results suggest that the ECB's asset purchases had a larger impact on industrial production in the countries where it drove down long-term interest rates the most via portfolio rebalancing channel. Despite that, our evidence suggests that the APP was mainly transmitted to inflation via exchange rate depreciation rather than through aggregate demand-driven shifts in the Phillips curve.
Highlights
The estimated elasticities of the euro area macroeconomic and financial variables to the asset purchase shock are in line with the previous literature, suggesting that the asset purchase programme (APP) shock is well identified which is essential to further analyze country-level effects
Since the data sample includes several episodes of severe economic volatility, we introduce stochastic volatility in our GVAR by allowing variancecovariance matrix Σii,tt of the error term εεii,tt to change over time: εεii,tt~NN 0, Σii,tt, Σii,tt = UUiiHHii,ttUUi′i where UUii is a lower triangular matrix with a unit diagonal and HHii,tt is a diagonal matrix of log-volatilities denoted by hiiii,tt which follow an AR(1) process: hiiii,tt = μμiiii + ρρiiii hiiii,tt−1 − μμiiii + kkiiii,tt where μμiiii is the mean of log-volatility, ρρiiii is the persistence parameter and kkiiii,tt is a white noise error
Our results suggest that the asset purchase programme (APP) has had a limited and weakly significant impact on Latvia's output with the effect being among the lowest in the euro area, contrary to the existing literature, which evaluates the spillovers from the European Central Bank (ECB) monetary policy to the Latvian economy
Summary
The estimated elasticities of the euro area macroeconomic and financial variables to the asset purchase shock are in line with the previous literature, suggesting that the APP shock is well identified which is essential to further analyze country-level effects. The results from both models suggest that the APP has had a rather limited impact on Latvian output because the impulse response of the industrial production is only statistically significant at 50% level in the case of multilateral model, likely reflecting the importance of spillovers from non-euro area countries in the transmission of the APP to the Latvian economy.
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