Monetary Policy In Euro Area Research Articles

Examining asymmetries in the transmission of monetary policy in the euro area: Evidence from a mixed cross-section global VAR model

I estimate the transmission of a common euro area monetary policy shock across individual euro area economies. To do so, I develop a global VAR model in which all euro area economies are included individually while, at the same time, their common monetary policy is modelled as a function of euro area aggregate output growth and inflation. The results suggest that the transmission of monetary policy across euro area economies displays asymmetries, and that, in line with economic theory, these are driven by differences in economies׳ structural characteristics. In particular, euro area economies in which a higher share of aggregate output is accounted for by sectors servicing interest rate sensitive demand exhibit a stronger transmission of monetary policy to real activity. Similarly, even though the evidence is less conclusive, euro area economies which feature more real wage and/or fewer unemployment rigidities also appear to display a stronger transmission of monetary policy to real activity.

Financial Stability Considerations for Slovakia in the Context of ECB Monetary Stance

Abstract The Euro Area monetary policy has been recently facing many challenges. To meet its objectives related to the price stability, the ECB has been conducting an accommodative policy including several extraordinary measures. Apart from improvements in inflationary expectations, these moves, however, also lead to very low interest rates and flattening of the yield curve. In our work, we examine potential negative impacts of this environment on European banks with particular focus on the Slovak banking sector via narrowing of interest margins and growing indebtedness of households. We show this impact to be asymmetrical within the Euro Area mostly due to divergence of banks’ business models. These results are consequently interpreted in the context of banks's lending policies and capital buffers. Results of our work underline the importance of active macro-prudential policy conducted at national level aimed at offsetting unintended side effects of current monetary policy in the Euro Area.

Sovereign Bond Purchases and Risk-Sharing Arrangements Implications for Monetary Policy

The design of the euro area Quantitative Easing (QE) programme raises the question of whether insufficient liquidity in the bond markets will reduce the impact of the programme and lead to market volatility. While estimates suggests that scarcity of around €102 billion may arise over the life of the programme, to date the QE programme has met its monthly targets and bond market volatility has been managed. Questions also arise in respect of the fact that risk is not fully shared on up to €738.4 billion to be purchased over the life of the programme. Partial risk sharing raises the spectre of defaulting central banks exiting the euro system, and existing members being unwilling to bear associated costs, and thus the future of the euro area. However, estimations suggest that, at present, all national central banks should be able to bare losses stemming from sovereign debt purchases under the current round of QE.This report was prepared within a research project entitled Sovereign bond purchases and risk sharing arrangements: Implications for euro-area monetary policy, which received funding from the European Parliament.

Euro area monetary policy transmission in Estonia

This paper studies the effect of a monetary policy shock in the euro area on the main Estonian economic and financial variables between 2000 and 2012. Using a standard structural vector autoregression (SVAR) model we find strong and persistent effects on Estonian GDP, private consumption, corporate investment, and imports. A monetary policy shock also has strong and sluggish effects on the housing loan and consumer credit interest rates. The estimated reaction of Estonian GDP and the GDP deflator-based inflation rate is about four times stronger than the reaction of euro area-wide aggregates. The strength of the impact depends on the inclusion of the data from the years of the recent financial and economic crisis.

Euro Area Monetary Policy Shocks: Impact on Financial Asset Prices During the Crisis?

We use high-frequency intraday interest rate data to measure euro area monetary policy shocks on the days of ECB interest rate announcements between 2002 and 2013. In line with Gurkaynak et al. (2005), we look at monetary policy shocks along two time dimensions: one related to the current level of short-term interest rates and a second related to expectations for the future path of these rates. We undertake regression analysis in order to determine the impact of monetary policy shocks on euro-denominated financial asset prices and confirm that shocks related to the future path of monetary policy are an important driver, particularly for longer-term bond yields. We find that this relationship has changed for certain asset classes since the onset of the crisis, notably the sovereign bonds of stressed euro area countries. These findings highlight the changed nature of the monetary policy transmission mechanism for some euro area countries during the sovereign debt crisis.

RELATIVE PURCHASING POWER PARITY AND THE EUROPEAN MONETARY UNION: EVIDENCE FROM EASTERN EUROPE

ABSTRACT. This paper examine whether relative purchasing power parity holds for Albania, Bulgaria, Croatia, FYR Macedonia, Romania and Turkey versus Germany over the period January 1999 to May 2013. We investigate the real exchange rate by using a Dickey-Fuller test. Thereafter, we investigate the real exchange rate by allowing for a trend with the origin in the Balassa-Samuelson effect. We also investigate the same pairs using the Engle-Granger cointegration test. However, for the Engle-Granger cointegration test, four of the pairs are excluded as the nominal exchange rate and the price differential are not integrated by the same order. We have investigated the half-life of each pair in each of the three approaches. We find ambiguous results both regarding relative PPP and the speed of adjustment towards the PPP equilibrium. We use the results to investigate whether the Albanian, Bulgarian, Croatian, FYR Macedonian, Romanian and Turkish economies are synchronized with the German economy and if they are ready to enter the European Monetary Union.JEL Classification: E5, E31 F33Keywords: Consumer Price Index, Monetary Policy, Monetary System, Currency Union, EMU, Exchange Rates, Economic Indicators(ProQuest: ... denotes formulae omitted.)IntroductionThere is today a wide discussion in Europe concerning which countries to include in the European Monetary Union (EMU) and how these countries (and the EMU itself) will benefit from a membership. Schadler, Drummon, Kuijs, Murgasova and Elkan (2005) argue that, for countries adopting the Euro, the trade-off is between gain in trade and growth and increased volatility as a result of losing the exchange rate as a shock absorber. Further they conclude that for central European countries (CEC), an adoption of the Euro will hasten real convergence and will at most suffer a modest increase in volatility. The basic question comes down to: when and how to adopt the Euro (Schadler, Drummond, Kuijs, Murgasova, & Elkan, 2005).One deterministic factor for the loss of increased volatility is the optimum currency area (OCA) criteria. The OCA captures the sensitiveness of a country's economy to real shocks that are asymmetric to those in the currency union. The OCA therefore measures how often the Euro-area monetary policy is likely to be different from the monetary policy necessary for the potential incoming country. In other words, the OCA measures whether the economic cycles in the Euro-area and the economic cycles in the potential EMU-client are synchronized. The OCA criteria also focus on how well the potential client can adopt to shocks without their own monetary policy (Schadler, Drummond, Kuijs, Murgasova, & Elkan, 2005).This paper discusses relative purchasing power parity (PPP) in some of the countries in the Balkan area versus Germany, which is the largest economy in the EMU. Findings that suggest that PPP holds do not automatically suggest that OCA criteria are fulfilled and that the economies are synchronized. However, positive finding in regards of PPP implies that the real exchange rates share common trends and are driven by economic fundamentals. Thus, positive findings of PPP suggest that the analyzed country is suitable to adopt the euro regarding the terms discussed above (Caporale, Ciferri, & Girardi, 2008). The countries examined in this paper are Albania, Bulgaria, Croatia, FYR Macedonia, Romania and Turkey.Purchasing Power ParityPPP is the simple idea that arbitrage enforces national price levels to be equal after converted to the same currency (Rogoff, 1996). Rogoff (1996) writes that most economists believe that PPP is a long term anchor for real exchange rates; however, few take PPP seriously as a short term proposition. There are several variants of PPP.The Law of one PriceThe strictest version of PPP is the law of one price (LOP). The LOP states that after converting prices to one common currency, any good should have the same price across countries. …

Financial Indicators Signalling Correlation Changes in Sovereign Bond Markets

We use a Smooth Transition Conditional Correlation GARCH (STCC-GARCH) model applied to the euro area monetary policy rates and sovereign yields of Italy, Spain and Germany at 5-year maturity to estimate the threshold level of the signals above which the sovereign bond market moves to a crisis regime. We show that the threshold to a crisis regime for Italy and Spain is reached when (i) their 5-year sovereign yield spreads amount to 80-90 basis points; (ii) their 5-year CDS spreads amount to 120-130 basis points or (iii) the 5-year spread between the Kreditanstalt fur Wiederaufbau (KfW) bond and the German Bund amounts to 25 basis points. Using impulse responses, we find that the STCC-GARCH with the KfW-Bund spread has leading properties, a feature corroborated by the fact that this indicator suggested a shift to a crisis regime already in August 2007 and has been signalling an improvement of the situation already in the autumn of 2012. An out-of-sample forecast of the STCC-GARCH model is also provided, which is both a novelty and a further robustness check for the stability of the model.

TARGET2 and central bank balance sheets

The euro area's TARGET2 payments system has featured heavily in academic and popular discussions of the euro crisis. Some of this commentary has described the system as being responsible for a secret bailout of Europe's periphery. Another common theme has been that the system has built up large credit risks for Germany should the euro break up. This paper discusses the TARGET2 system, focusing in particular on how it impacts the balance sheets of the central banks that participate in the system. It discusses the factors driving TARGET2 balances, considers some counterfactual cases in which euro area monetary policy operated differently, examines the risks to Germany and considers proposals for settlement of these balances.

Inference on Structural Breaks using Information Criteria

This paper investigates the usefulness of information criteria for inference on the number of structural breaks in a standard linear regression model. In particular, we propose a modified penalty function for such criteria, which implies each break is equivalent to estimation of three individual regression coefficients. A Monte Carlo analysis compares information criteria to sequential testing, with the modified Bayesian and Hannan–Quinn criteria performing well overall, for data‐generating processes both without and with breaks. The methods are also used to examine changes in Euro area monetary policy between 1971 and 2007.

A more effective euro area monetary policy than OMTs — gold-backed sovereign debt

Given the shortcomings of the current responses to the sovereign debt crisis in the eurozone, the author proposes utilising national gold reserves as collateral for government debt. Gold backing would be quite attractive to bond investors and would significantly ease the burden of high sovereign debt yields, particularly in Portugal and Italy. Moreover, it would achieve this without adding further risky assets to the European Central Bank’s balance sheet and thereby transferring credit risk to Northern European countries.

Heterogeneous Transmission Mechanism: Monetary Policy and Financial Fragility in the Euro Area

The Euro area economic activity and banking sector have shown substantial fragility over the last years with remarkable country heterogeneity. Using detailed data on lending conditions and standards, we analyse how financial fragility has affected the transmission mechanism of the single Euro area monetary policy during the crisis until the end of 2011. The analysis shows that the monetary transmission mechanism has been time-varying and influenced by the financial fragility of the sovereigns, banks, firms and households. The impact of monetary policy on aggregate output is stronger during the financial crisis, especially in countries facing increased sovereign financial distress. This amplification mechanism, moreover, operates mainly through the credit channel, both the bank lending and the non-financial borrower balance-sheet channel. Our results suggest that the bank-lending channel has been partly mitigated by the ECB nonstandard monetary policy interventions. At the same time, when looking at the transmission through banks of different sizes, it seems that, until the end of 2011, the impact of credit frictions of borrowers have not been significantly reduced, especially in distressed countries. Since small banks tend to lend primarily to SME, we infer that the policies adopted until the end of 2011 might have fall short of reducing credit availability problems stemming from deteriorated firm net worth and risk conditions, especially for small firms in countries under stress. JEL Classification: E44, E52, E58, G01, G21, G28

Monetary policy and stock prices in small open economies: Empirical evidence for the new EU member states

This study presents evidence on the effect of domestic and Euro Area monetary policy on stock prices in four new EU member states of Central Europe and the main determinants of stock price volatility, estimating structural vector autoregressive models identified with short-run restrictions. We find that stock prices in the considered new EU member states are more sensitive to changes in the Euro Area interest rate than to the domestic one. Moreover, the bulk of stock price volatility in these countries is due to shocks related to exchange rate and Euro Area monetary policy. Overall, we find that local stock markets are more sensitive to external shocks than to domestic ones.

Unveiling the monetary policy rule in the Euro-area

This paper provides evidence that, since the sign of Maastricht Treaty, euro-area monetary authorities mainly follow a strong anti-inflationary policy. This policy can be described by a threshold monetary policy rule model which allows for distinct inflation policy regimes: a low and high. The paper finds that these authorities react more strongly to positive deviations of inflation and/or output from their target levels rather than to the negative. They do not seem to react at all to negative deviations of output from its target level in the low-inflation regime. We argue that this behaviour can be attributed to the attitude of the monetary authorities to build up credibility on stabilizing inflationary expectations. To evaluate the policy implications of the above euro-area monetary policy rule behaviour, the paper simulates a small New Keynesian model. This exercise clearly indicates that the absence of reaction of the euro-area monetary authorities to negative output gap when inflation is very low reduces their efficiency on dampening the effects of negative demand shocks on the economy.

US–Euro Area Monetary Policy Interdependence: New Evidence from Taylor Rule‐based VECMs

Abstract(1227) Ansgar Belke and Yuhua CuiThis paper analyses the monetary policy interdependence between the European Central Bank (ECB) and the Federal Reserve (Fed) for the period 1999–2006. Two models are specified: a partial vector error correction model (VECM) and a general VECM. In the partial VECM, we look for a long‐run interdependent relationship between the interest rates of the two currency areas and specify the Taylor Rule terms as exogenous variables. In the general VECM, we regard all variables as endogenous, and look for long‐run equilibrium relationships among them, which may reveal monetary policy interdependence between the two central banks. Weak exogeneity is checked in both models in order to establish a possible leader–follower relationship. The empirical results of both models indicate interdependence between the ECB and the Fed, but only the general VECM testifies a leader–follower pattern between the two central banks. According to this pattern, the ECB does follow the Fed.

Towards a Robust Monetary Policy Rule for the Euro Area

Estimations of simple monetary policy rules are often very rigid. Standard practice requires that a decision is made as to which indicators the central bank is assumed to respond to, ignoring the data-rich environment in which policy-makers typically form their decisions. However, the choice of the feedback variables in the estimations of simple rules bears non-trivial implications for the prescriptions borne from these rules. This paper addresses this issue for the euro area using a new comprehensive real-time database for the euro area and examines the ECB’s past interest-rate setting behaviour in two complementary ways that are designed to deal with both model and data uncertainty. In a first step we follow the “thick-modelling” approach suggested by Granger and Jeon (2004) and estimate a series of 3,330 policy rules. In a second step we employ a factor-model approach similar to Bernanke and Boivin (2003) for the US Fed, but with structurally interpretable factors a la Belviso and Milani (2006). Taken together, we find a strong justification for the need of adopting robust approaches to describe the historical evolution of euro area monetary policy. We also find that the ECB is neither purely backward nor forward-looking, but reacts to a synthesis of the available information on the current and future state of the economy. JEL Classification: C50, E52, E58

Evaluating the Stresses from ECB Monetary Policy in the Euro Area

This paper investigates the extent to which euro area monetary policy has responded to evolving economic conditions in individual member states as opposed to the euro area as a whole. Based on a forward-looking Taylor rule-type policy reaction function, we conduct counterfactual exercises that compare the monetary policy behaviour of the ECB under alternative hypothetical scenarios: (1) the euro member states make individual policy decisions, and (2) the ECB responds to the economic conditions of individual members. Stress measures are then constructed to evaluate the degree of divergence of member state economies under these two hypothetical scenarios. The results we obtain reflect the extent of heterogeneity among the national economies in the monetary union, indicating that euro area policy rates have been particularly close to the ‘counterfactual’ interest rates of the largest euro members and countries with similar economic conditions, namely Germany, Austria, Belgium and France.

The Role of Labor Markets for Euro Area Monetary Policy

In this paper, we explore the role of labor markets for monetary policy in the euro area in a New Keynesian model in which labor markets are characterized by search and matching frictions. We first investigate to which extent a more flexible labor market would alter the business cycle behaviour and the transmission of monetary policy. We find that while a lower degree of wage rigidity makes monetary policy more effective, i.e. a monetary policy shock transmits faster onto inflation, the importance of other labor market rigidities for the transmission of shocks is rather limited. Second, having estimated the model by Bayesian techniques we analyze to which extent labor market shocks, such as disturbances in the vacancy posting process, shocks to the separation rate and variations in bargaining power are important determinants of business cycle fluctuations. Our results point primarily towards disturbances in the bargaining process as a significant contributor to inflation and output fluctuations. In sum, the paper supports current central bank practice which appears to put considerable effort into monitoring euro area wage dynamics and which appears to treat some of the other labor market information as less important for monetary policy.

The role of labor markets for euro area monetary policy

In this paper, we explore the role of labor markets for monetary policy in the euro area in a New Keynesian model in which labor markets are characterized by search and matching frictions. We first investigate to which extent a more flexible labor market would alter the business cycle behavior and the transmission of monetary policy. We find that while a lower degree of wage rigidity makes monetary policy more effective, i.e. a monetary policy shock transmits faster onto inflation, the importance of other labor market rigidities for the transmission of shocks is rather limited. Second, having estimated the model by Bayesian techniques we analyze to which extent labor market shocks, such as disturbances in the vacancy posting process, shocks to the separation rate and variations in bargaining power are important determinants of business cycle fluctuations. Our results point primarily towards disturbances in the bargaining process as a significant contributor to inflation and output fluctuations. In sum, the paper supports current central bank practice which appears to put considerable effort into monitoring euro area wage dynamics and which appears to treat some of the other labor market information as less important for monetary policy.

Euro Area Monetary Policy in Uncharted Waters

Euro Area Monetary Policy in Uncharted Waters

Euro Area Monetary Policy in Uncharted Waters

We analyze the European Central Bank's (ECB's) response to the global financial crisis. Our results suggest that even during the crisis, the core part of ECB's monetary policy transmission-from policy rates to market rates-has continued to operate, but at a decreased efficiency. We also find some evidence that the ECB's non-standard measures, namely the lengthening of the maturity of monetary policy operations and the provision of funds at the fixed rate, reduced money market term spreads, facilitating the pass-through from policy to market rates. Furthermore, the results imply that the substantial increase in the ECB's balance sheet may have contributed to a reduction in government bond term spreads.