The implications of diversity in consumption behaviour for the choice of monetary policy rules in Europe

Abstract

Differences in economic structures across countries have potentially important implications for the conduct of monetary policy in the Euro Area. One facet of this lies in consumer expenditure behaviour. Our objective is to analyse the policy implications of assuming maximal and minimal differences between European economies using the National Institute's Global Econometric Model. We assess the performance of three possible ECB monetary policy rules under these different scenarios, using measures of the volatility of prices and output. We take as our benchmark a fully heterogeneous Europe, where individual country consumption functions are estimated separately. We estimate a homogeneous model for core European countries, incorporating countries into the core where it is statistically justified to pool them. We also estimate a fully homogeneous Europe where all Euro Zone countries are pooled. We find that the two ‘pillar strategy’ adopted by the ECB dominates other monetary policy frameworks.