The impact of unconventional monetary policy in the euro area. Structural and scenario analysis from a Bayesian VAR

Anastasios Evgenidis,Stephanos Papadamou

doi:10.1002/ijfe.2088

Abstract

AbstractThis paper employs a medium scale Bayesian VAR model to provide a rich picture of the transmission of unconventional monetary policy (UMP) shocks in various dimensions of the economy, and to shed light on the appropriate policy mix that the central bank could adopt to fulfil its price stability mandate. We show that UMP shocks have a significant positive impact on both economic activity and inflation; stem financial market stress episodes and boost economic sentiment. Additionally, several channels seem to have been activated, including the exchange rate, inflation expectations and the bank lending channel. Counterfactual policy analysis suggests that a policy mix that combines the use of permanently negative interest rates with a balance sheet expansion at a steady pace over a long period, could bring inflation closer to the target. Alternative policy scenarios that, either give more weight on the purchases during the first months or, terminate asset purchases too early, would fail to keep inflation on track to meet its target.

Highlights

Unconventional monetary policies in the euro area gained prominence in the wake of the 2007–08 financial crisis as traditional monetary policy tools proved less effective in tackling the financial crisis, providing the required liquidity, and fighting disinflation
What are the effects of unconventional monetary policy (UMP) shocks in the Eurozone? Does the expansion of the central bank's balance sheet help the euro area to spur economic growth, raise inflation and inflation expectations, boost bank lending and lower financial stress levels? what is the appropriate central bank's policy mix to achieve price stability? For example, could the continuation of quantitative easing (QE) over a longer period, combined with permanently negative deposit rates, lead inflation close and below 2 %, or maybe a forceful, frontloaded UMP would be preferred? This paper addresses these questions from a different angle that to our knowledge innovates and contributes in filling some existing gaps in the UMP literature in the following ways
Our goal is to find out the appropriate policy mix of interest rates and balance sheet policies so that the central bank delivers on its mandate of price stability

Summary

| INTRODUCTION

Unconventional monetary policies in the euro area gained prominence in the wake of the 2007–08 financial crisis as traditional monetary policy tools proved less effective in tackling the financial crisis, providing the required liquidity, and fighting disinflation. As Christiano, Eichenbaum, and Evans (1999) and Bernanke, Boivin, and Eliasz (2005) highlight, a potential consequence of this problem is the Sims (1992) interpretation of the “price puzzle.” This refers to the standard finding in the VAR literature that a tightening monetary policy shock is followed by a slight increase in the inflation rate, rather than a decrease as expected. This small number of variables is unlikely to reflect the information available to central banks.

| LITERATURE REVIEW

| EMPIRICAL RESULTS

| CONCLUSION

Findings

A P P END I X : ROBUSTNESS CHECKS