European Monetary Policy Research Articles

Has the transmission mechanism of European monetary policy changed in the run-up to EMU?

This paper studies empirically the transmission mechanism of European monetary policy by means of time-varying, heterogeneous coefficient models estimated in a numerical Bayesian fashion. Based on pre-European Monetary Union evidence from Germany, France, Italy, and Spain, we find that (i) the long-run cumulative impact on output of a common, homoskedastic monetary policy shock has decreased in all countries after 1991. These declines are statistically significant and accompanied by some changes in the conduct of monetary policy over the same period. At the same time, we also find that (ii) cross-country differences in the effects of this shock have not decreased over time.

Vermogenspreise und Konsum: Neue Erkenntnisse, amerikanische Erfahrungen und europaische Herausforderungen*

The article illustrates how the integration of modern theory of finance and stochastic dynamic macroeconomic analysis provides a deeper understanding of the link between asset prices and consumption. It shows that this approach gives only a partial explanation for recent trends in US consumption. Comparing wealth effects in Anglo-Saxon countries with continental Europe, the article provides a perspective of the challenges for European monetary policy arising from wealth effects on consumption.

Dual Long Memory in Inflation Dynamics across Countries of the Euro Area and the Link between Inflation Uncertainty and Macroeconomic Performance

This paper analyzes the inflation dynamics of several countries belonging to the European Monetary Union and of the UK. We estimate the two main parameters driving the degree of persistence in inflation and its uncertainty using a dual long memory process. We also investigate the possible existence of heterogeneity in inflation dynamics across Euro area countries and examine the link between nominal uncertainty and macroeconomic performance measured by the inflation and output growth rates. Strong evidence is provided for the hypothesis that increased inflation raises nominal uncertainty in all countries. However, we find that uncertainty surrounding future inflation has a mixed impact on output growth. This result brings out an important asymmetry in the transmission mechanism of monetary policy in Europe in addition to the difference in the economic sizes of the countries. We also investigate whether one can find a correlation between central bank independence and inflation policy. Our conclusion is that the most independent central banks are in countries where inflation falls in response to increased uncertainty.

Nonlinear monetary policy in Europe: fact or myth?

We hold the fort for linear specification of monetary policy and economic activity in Europe. Using data on the last two and a half decades, we cannot reject the hypothesis that monetary policy is a linear process and we find mixed results regarding economic activity.

European Monetary and Fiscal Policies after the EU Enlargement

This paper examines the design of macroeconomic policies after Central and Eastern European countries (CEECs) have joined the EU. We consider scenarios with and without CEECs being members of the European Economic and Monetary Union (EMU) and analyze consequences of different intermediate targets for the European Central Bank. For the fiscal policy variables, we assume that the governments of incumbent and new members either refrain from pursuing active stabilization policies or follow either non-cooperative or cooperative activist fiscal policies. Different scenarios are simulated with the macroeconomic McKibbin–Sachs Model (MSG2 Model), and the resulting welfare orderings are determined. They show that the advantages and disadvantages of different policy arrangements depend strongly on the nature of the shock the economies are faced with. Additional macroeconomic noise resulting from the CEECs' membership of the EMU does not seem to be too much of a problem.

Inflation, Inflation Uncertainty and a Common European Monetary Policy

The relationship between inflation and inflation uncertainty is investigated in six European Union countries for the period 1960–99. Exponential generalized autoregressive conditional heteroscedasticity models are used to generate a measure of inflation uncertainty and then Granger methods are employed to test for causality between average inflation and inflation uncertainty. In all the European countries except Germany, inflation significantly raises inflation uncertainty as predicted by Friedman. However, in all countries except the UK, inflation uncertainty does not cause negative output effects, implying that a common European monetary policy applied by the European Central Bank might lead to asymmetric real effects via the inflation uncertainty channel. Less robust evidence is found regarding the direction of the impact of a change in inflation uncertainty on inflation. In Germany and the Netherlands, increased inflation uncertainty lowers inflation, while in Italy, Spain and, to a lesser extent, France increased inflation uncertainty raises inflation. These results are generally consistent with the existing rankings of central bank independence.

Bashing and supporting central banks: the Bundesbank and the European Central Bank

In this paper, we analyse the influences leading to external pressure on or public support for German and European monetary policy. Based upon the findings for the Deutsche Bundesbank, lessons are drawn for the European Central Bank (ECB). We show that external pressure on the ECB stems mainly from politicians or from international organisations (such as the IMF). In contrast with evidence for the Bundesbank, interest groups (such as commercial banks) hardly attempt to influence European monetary policy. German data show that factors leading to external pressure on the central bank are rising unemployment and the threat that governments will lose their majority in the next election. Evidence for the latter is, however, weak, and we show that in any case this source of pressure is likely to be of minor importance for the ECB.

Tax Systems, Financial Integration and Efficiency of European Capital Markets

This paper provides a critical assessment of the evolution of taxation of income from capital in Europe during the past decade.The introduction of the single currency has paved the way for important changes in European financial markets. Taxation of income from capital is one of the most important factor affecting investment decision. Proper measurement of cost of capital and return on investment cannot afford to ignore the wedges created by tax liabilities, as relative return on financial assets can be substantially altered when tax rates are brought to bear on the cost-benefit analysis of security holding and trade. To be sure, taxes are not alone in throwing sand-in-the-gears into European financial markets: trade and post-trade transaction and settlement costs as well as regulatory constraints may be hampering cross-border capital flows significantly. Substantial improvements in the efficiency of the European markets for fixed income securities, especially the degree of government and corporate bond market integration have been achieved in the nineties. Such efficiency gains can be largely attributed to the successful unification of monetary policy in Europe. As far as tax reform is concerned, the granting of tax-exempt status to foreign investment has been an important factor in fostering convergence in bond yields across Europe. Nowadays tax wedges implicit in bond yields and spreads appear to be quantitatively very small, if present at all. In contrast to the unsecured segment of the money and bond market, integration of the collateralised segment (repo market) has progressed at a slower pace. Also, the integration of European stock markets has proceeded at a relatively slow pace when compared to the rapid convergence of money and bond markets. As a result, benefits from geographical diversification of European stocks, over and above sectoral allocation, can still be gained under the single currency, despite the rising importance of industry allocation vis-a-vis country factors in driving stock returns in Europe.Our preliminary econometric evidence reported in this paper confirms that differential taxation drives a non-negligible wedge across stock market returns and valuation in Europe, as well as relative returns among large currency blocs (Europe, United States and Japan).

The French commitment to European monetary integration: A review of the two EMS crises (1981–83, 1992–93)

This paper focuses on the process of exchange rate management during the two European Monetary System(EMS) crises, in 1981–83 and 1992–93, and examines the factors which led the French governments to adhere to the EMS. France's strong franc (franc fort) policy is a useful test case for maintaining national commitment to European monetary integration. The origin of the franc fort policy can be traced back to the exchange rate crisis of 1981–83. By actively supporting European institutions and emphasizing the emergence of a strong and united European common currency, France discovered the way to bolster confidence in her economic policy. Beyond this focal point, political justification and economic rationality became mutually reinforcing, configuring French national preference in European monetary integration. The response of the French government to the EMS crisis of 1992–93 was more consistent compared to the response to the 1981–83 crisis, and reflected the accumulation of loyalty to European monetary integration. This loyalty, however, was made neither from purely economic calculation nor out of normative commitment French European monetary policy reflected the interaction between domestic politics and European monetary integration. The French commitment to the franc fort also was based on domestic political bases such as the existence of a core policy group, a centralized policy‐making structure, and an issue linkage between the franc fort and European integration.

EMU and the Regional Impact of Monetary Policy

RODRíGUEZ-FUENTES C. J. and DOW S. C. (2003)EMU and the regional impact of monetary policy, Reg. Studies 37, 969–980. In this paper we focus on a topic which has been attracting renewed interest because of monetary unification in Europe: the regional dimension of national monetary policies. Most of the debate over the regional implications of the Euro has been developed within the Optimum Currency Area framework.According to this theory, European monetary policy would have regional effects when the countries of the Euro-zone had such structural differences as to produce asymmetric shocks. These asymmetrical effects could only be offset by labour mobility and wage/price flexibility. However, we argue here that, in addition, European monetary policy may have more general regional effects, including in particular by producing a higher instability in the pattern of credit availability for some peripheral regions. This latter possibility,and the forces underlying it, are explored here both at the theoretical level and the empirical level, examining the process by which monetary policy is transmitted.RODRíGUEZ-FUENTES C. J. et DOW S. C. (2003)L'Ume et les effets régionaux de la politique monétaire,Reg. Studies 37, 969–980. Cet article porte sur une question qui a fait couler beaucoup d'encre suite à l'unification monétaire européenne: à savoir, l'étendue régionale des politiques monétaires nationales. Le débat a porté dans une large mesure sur les effets régionaux de l'euro dans le cadre d'une Zone monétaire optimale. Selon cette théorie-là, la politique monétaire européenne aurait des effets régionaux au moment oùles pays-membres de la zone euro auraient des écarts structurels tels qu'il se produirait des chocs asymétriques. Ces effets asymétriques ne pourraient être compensés que par la mobilitéde la main-d'oeuvre et par la flexibilité des salaires et des prix. Cependant, on affirme que la politique monétaire européenne pourrait avoir d'autres effets régionaux plus généraux, y compris notamment un accroissement de l'instabilité de la structure de la possibilité d'obtenir des crédits pour ce qui est de certaines régions périphériques.Cette dernière question, et ses forces motrices,se voit examinée à la fois au niveau théorique et sur le plan empririque, en examinant le processus par lequel la politique monétaire est transmise.RODRíGUEZ-FUENTES C. J. undDOWS. C. (2003) Die europäische Währungsunion und die regionale Auswirkung der Währungspolitik, Reg. Studies 37, 969–980. In diesem Aufsatz wird ein Thema angesprochen, das wegen der Vereinheitlichung der Währung in Europa erneutes Interesse erweckt hat: die regionale Dimension der staatlichen Wahrungspolitik. Ein Großteil der Debatteüber regionale Auswirkungen des Euro ist im Rahmen des Optimalen Währungsgebietes (Optimal Currency Area) aufgetaucht. Dieser Theorie zufolge würde die europäische Währungspolitik regionale Auswirkungen haben, wenn die Länder der Eurozone derartige strukturelle Unterschiede aufwiesen, daß sie asymmetrische Schocks verursachten. Diese asymmetrischen Auswirkungen könnten nur durch die Mobilität der Arbeiterschaft und Elastizität von Löhnen und Preisen aufgefangen werden. Die Autoren stellen hier jedoch die Behauptung auf, daß die europäische Währungspolitik zusätzlich weitere, allgemeine regionale Auswirkungen haben könne, unter anderem besonders die Schaffung vermehrter Instabilität im Muster der Kreditvergebung für gewisse peripherale Regionen. Diese letztere Möglichkeit, und die ihr zugrunde liegenden Kräfte werden hier sowohl auf theoretischer wie auf impirischer Ebene untersucht,indem sie den Vorgang prüfen, durch den Währungspolitik vermittelt wird.

Robust European monetary policy rules

This note applies H ∞ methods to an estimated hybrid monetary policy model and derives standard and robust optimal interest rate rules. We find that the ‘robust’ central banker responds more aggressively than it does without concerns for robustness and that the responses of the state variables in this case are not necessarily always stronger than the standard ones.

Monetary Policy Announcements and Money Markets: A Transatlantic Perspective

AbstractThis paper investigates how money markets in the USA, Germany (up to 1998) and the euro area (since 1999) react to monetary policy announcements by the Federal Reserve, Bundesbank and ECB. We find that interest rates respond strongly to domestic monetary policy throughout, whereas the response to foreign monetary policy varies across markets and over time: both the German and the euro area market react to Federal Reserve announcements, whereas US markets do not generally respond to European monetary policy. Whereas announcements by the Bundesbank increased the volatility of German money markets, such effects are rarely found for the ECB, and have basically disappeared for the Federal Reserve. Moreover, the general linkage of money markets has increased considerably over time: interest rate developments and volatility in either the USA or the euro area are generally mirrored in the other market to a much larger extent than prior to EMU. We interpret these results as evidence that euro area and US markets not only have become more interdependent over time, but that the markets' understanding and anticipation of monetary policy decisions have improved over time.

Robust European Monetary Policy Rules

This note applies H-infinite methods to an estimated hybrid monetary policy model (cf. Sahuc, Applied Economics Letters, 9, pp. 949-55, 2002) and derives standard and optimal interest rate rules. We find that the robust central banker responds more aggressively than it does without concerns for robustness and that the responses of the state variables in this case are not necessarily always stronger than the standard ones.

European monetary policy: Institutional design and policy experience

The following article examines design issues relevant to European monetary policy: central bank independence, and the accountability and transparency of monetary policy strategy. An empirical approach is then applied which allows a comparison between the ECB and other central banks. It also enables an investigation of whether the ECB simply follows the US Federal Reserve Bank, as is sometimes claimed.

The Future of the Stability and Growth Pact

Books reviewed in this article:Anne Brunila, Marco Buti and Daniele Franco (eds), The Stability and Growth Pact: The Architecture of Fiscal Policy in EMUMarco Buti, Jurgen von Hagen and Carlos Martinez‐Mongay (eds), The Behaviour of Fiscal Authorities: Stabilization, Growth and InstitutionsMarco Buti and Andre Sapir (eds), EMU and Economic Policy in Europe: The Challenge of the Early YearsSylvester C. Eijffinger and Jakob de Haan, European Monetary and Fiscal Policy

Dynamic Game Theory: Modeling International and National Economic Strategic Interactions

Drawing on the author's recent research, this paper shows how the theory of dynamic games can be applied to problems of economic policy-making with heterogeneous policy-makers. In particular, for the case of the European Economic and Monetary Union (EMU), strategic interactions between governments of the EMU member countries responsible for national fiscal policies, the European Central Bank responsible for European monetary policy, and possibly policy-makers of other countries can be studies in a fruitful way, using concepts and results from dynamic game theory as applied to a large macro-econometric global model. It is investigated whether discretionary or rule-based policies and whether non-cooperative or cooperative policies for Europe result in a better performance as measured by intertemporal objective functions. The results show that the answers to these questions depend strongly on the nature of the shock to which European and other economies are exposed.

Voting on monetary policy in the Council of the European Central Bank

This paper challenges the received view that, from the monetary policy standpoint, EMU is a sure loss since participating countries relinquish a useful stabilisation instrument with no credibility benefit if they are equally averse to inflation. The single European monetary policy is decided by majority voting within the Council of the European Central Bank—a collegiate body consisting of the members of the Executive Board and the governors of the participating countries who are assumed to entertain Union-wide and national stabilisation objectives, respectively. The incentive structure originating from repeated voting and conflicting national interests provides an effective commitment device that reduces the inflationary bias and can offset the welfare loss due to the poorer stabilisation performance of the single monetary policy. However, this common advantage may well be accompanied by a very unequal distribution across countries of the stabilisation benefits from the single monetary policy, despite the presence of the members of the Executive Board.

Monetary policy in the Euro area ? lessons from the first years

This paper investigates in a consistent semi-structural empirical framework three current issues of monetary policy in the euro area. First, regarding policy transmission we offer a three-stage procedure to combine the estimation of economic structure prior to EMU with current ECB monetary policy. Second, we test whether the regime change leads – before or after – EMU to structural instability. Third, we investigate the stance of monetary policy in Europe. We compare a “counterfactual” ECB reaction function based on average interest rates prior to EMU with actual ECB policy. Furthermore, we analyse actual ECB policy with interest rate projections using Bundesbank reaction functions and euroland data.

The Logic of Collective Responsibility in European Monetary Integration

Although European Monetary Union led to the creation of one of the world's most independent central banks, politics has not been removed from monetary integration. The European Central Bank's primary claim to legitimacy rests with its ability to deliver low inflation and presumably higher growth. Its independence may be insufficient for this task, making its relationship with political institutions like the Euro-12 and European Parliament more important over time in order to augment its own credibility. This article argues that a model of collective responsibility is more appropriate than one of principle-agent theory to describe the development of European monetary relations between the various institutions as they will need to rely on one another if a coherent European monetary policy is to take shape.

The bank: the birth of Europe's Central Bank and the rebirth of Europe's power

The European Central Bank starts operations on January 1st 1999. As the independent bank which issues euro banknotes and controls European monetary policy, it is one of the key financial institutions of the world - symbol of Europe's ever closer financial and political union, and the seminal driving-force behind Europe's growing world power in politics and economics. EUROPE'S CENTRAL BANK provides a first-hand account, based on access to the key players, of the intrigues and in-fighting surrounding the creation of the Bank and the appointment of its first president, the German-backed Dutchman Wim Duisenberg. It provides a detailed analysis of the Bank's operations and prospects, and a rigorous examination of all the related issues of European and global power - financial, economic, and political - including the impact of the Bank on the City of London's future as a world financial centre.