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Frank Smets

21 September 2021
OCCASIONAL PAPER SERIES - No. 280
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Abstract
From 2013 up to the launch of the ECB’s strategy review in January 2020, inflation in the euro area was low and over-predicted. This low inflation during the years 2013-19 can be attributed to a combination of interconnected factors. Cyclical developments account for a substantial share of the fall in underlying inflation, mainly in the first part of the low inflation period. Additionally, there is evidence that an underestimation of the amount of economic slack and less well-anchored longer-term inflation expectations, in combination with monetary policy in the euro area being constrained by the effective lower bound, have played an important role in the long period of subdued inflation. Ongoing disinflationary structural trends (such as globalisation, digitalisation and demographic factors) are likely to have had a dampening effect on inflation over the last few decades, but were in themselves not the main drivers of low inflation in the euro area from 2013 to 2019. However, as they could not have been easily offset by interest rate policy in an effective lower bound environment, they might also have contributed to the more subdued inflation dynamics in the euro area from 2013 to 2019.
JEL Code
C51 : Mathematical and Quantitative Methods→Econometric Modeling→Model Construction and Estimation
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
F62 : International Economics→Economic Impacts of Globalization→Macroeconomic Impacts
J11 : Labor and Demographic Economics→Demographic Economics→Demographic Trends, Macroeconomic Effects, and Forecasts
J30 : Labor and Demographic Economics→Wages, Compensation, and Labor Costs→General
21 September 2021
OCCASIONAL PAPER SERIES - No. 279
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Abstract
The existence of nominal rigidities and inflation differentials between countries offers two of the main rationales for an inflation buffer in a monetary union where monetary policy is oriented towards an area-wide inflation objective. Evidence accumulated since 2003 suggests that nominal rigidities remain a prevalent feature of the euro area, with some differences as regards prices and wages. Price setting may have become more flexible and there is no evidence for any especially strong downward rigidities in price setting. At the same time, persistent downward nominal wage rigidity (DWR) provides a strong argument for a positive inflation buffer to “grease the wheels” of the euro area economy – also in order to avoid the risk of macroeconomic adjustments being managed in terms of quantities (unemployment) rather than prices when DWR is binding and particularly when productivity growth is low. Inflation differentials across euro area countries have tended to be small but persistent. For inflation dispersion in the euro area, the across countries has been more important than across regions, confirming that an inflation buffer might be especially important in a monetary union of different countries. Overall, inflation differentials were due to the rise of economic and financial imbalances in the first decade of the euro and the subsequent need for adjustment. Balassa-Samuelson effects which were highlighted in the 2003 strategy review were only a minor factor. By and large, the ECB’s inflation objective seems to have provided a sufficient margin to prevent countries from having to live with prolonged periods of excessively low inflation rates in the period 1999-2019. There were some exceptions in the second decade of the euro (from 2009-2019), when inflation in the euro area was, overall, substantially lower than during the first decade.
JEL Code
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E24 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital
3 January 2020
WORKING PAPER SERIES - No. 2352
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Abstract
We study the incidence and severity of lower-bound episodes and the efficacy of three types of state-dependent policies—forward guidance about the future path of interest rates, large-scale asset purchases and spending-based fiscal stimulus—in ameliorating the adverse consequences stemming from the effective lower bound on nominal interest rates. In particular, we focus on the euro area economy and examine, using the ECB’s New Area-Wide Model, the consequences of the lower bound both for the near-term economic outlook, characterised by persistently low nominal interest rates and inflation, and in a lasting low-real-interest-rate world. Our findings suggest that, if unaddressed, the lower bound can have very substantial costs in terms of worsened macroeconomic performance. Forward guidance, if fully credible, is most powerful and can largely undo the distortionary effects due to the lower bound. A combination of imperfectly credible forward guidance, asset purchases and fiscal stimulus is almost equally effective, in particular when asset purchases enhance the credibility of the forward guidance policy via a signalling effect.
JEL Code
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy
2 January 2020
WORKING PAPER SERIES - No. 2349
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Abstract
We analyse the effects of supranational versus national banking supervision on credit supply, and its interactions with monetary policy. For identification, we exploit: (i) a new, proprietary dataset based on 15 European credit registers; (ii) the institutional change leading to the centralisation of European banking supervision; (iii) high-frequency monetary policy surprises; (iv) differences across euro area countries, also vis-à-vis non-euro area countries. We show that supranational supervision reduces credit supply to firms with very high ex-ante and ex-post credit risk, while stimulating credit supply to firms without loan delinquencies. Moreover, the increased risk-sensitivity of credit supply driven by centralised supervision is stronger for banks operating in stressed countries. Exploiting heterogeneity across banks, we find that the mechanism driving the results is higher quantity and quality of human resources available to the supranational supervisor rather than changes in incentives due to the reallocation of supervisory responsibility to the new institution. Finally, there are crucial complementarities between supervision and monetary policy: centralised supervision offsets excessive bank risk-taking induced by a more accommodative monetary policy stance, but does not offset more productive risk-taking. Overall, we show that using multiple credit registers – first time in the literature – is crucial for external validity.
JEL Code
E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
Network
Research Task Force (RTF)
20 December 2018
WORKING PAPER SERIES - No. 2219
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Abstract
On 1 June 2018 the ECB celebrated its 20th anniversary. This paper provides a comprehensive view of the ECB’s monetary policy over these two decades. The first section provides a chronological account of the macroeconomic and monetary policy developments in the euro area since the adoption of the euro in 1999, going through four cyclical phases “conditioning” ECB monetary policy. We describe the monetary policy decisions from the ECB’s perspective and against the background of its evolving monetary policy strategy and framework. We also highlight a number of the key critical issues that were the subject of debate. The second section contains a partial assessment. We first analyze the achievement of the price stability mandate and developments in the ECB’s credibility. Next, we investigate the ECB’s interest rate decisions through the lens of a simple empirical interest rate reaction function. This is appropriate until the ECB hits the zero-lower bound in 2013. Finally, we present the ECB’s framework for thinking about non-standard monetary policy measures and review the evidence on their effectiveness. One of the main themes of the paper is how ECB monetary policy responded to the challenges posed by the European twin crises and the subsequent slow economic recovery, making use of its relatively wide range of instruments, defining new ones where necessary and developing the strategic underpinnings of its policy framework.
JEL Code
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E42 : Macroeconomics and Monetary Economics→Money and Interest Rates→Monetary Systems, Standards, Regimes, Government and the Monetary System, Payment Systems
N14 : Economic History→Macroeconomics and Monetary Economics, Industrial Structure, Growth, Fluctuations→Europe: 1913?
G01 : Financial Economics→General→Financial Crises
19 June 2017
WORKING PAPER SERIES - No. 2076
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Abstract
Almost two decades after the introduction of the common currency differences in institutional frameworks remain a major source of cross-country heterogeneity in the eurozone. We develop a two-country model with incomplete international markets in which the availability of credit depends on the country’s institutional environment. Our main finding is that structural differences in domestic credit environments provide an explanation for the procyclicality of net capital inflows observed in the South of Europe. We show that frictions in domestic credit markets generate asymmetries in the transmission mechanism of shocks that are common to both regions.
JEL Code
F32 : International Economics→International Finance→Current Account Adjustment, Short-Term Capital Movements
F20 : International Economics→International Factor Movements and International Business→General
G17 : Financial Economics→General Financial Markets→Financial Forecasting and Simulation
23 March 2015
WORKING PAPER SERIES - No. 1767
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Abstract
We compare the labour market response to region-specific shocks in Europe and the US and to national shocks in Europe and investigate changes over time. We employ a multi-level factor model to decompose regional labour market variables and then estimate the dynamic response of the employment level, the employment rate and the participation rate using the region-specific variables and the country factors. We find that both in Europe and the US labour mobility accounts for about 50% of the long run adjustment to region-specific labour demand shocks and only a little more in the US than in Europe, where adjustment takes twice as long. In Europe labour mobility is a less important adjustment mechanism in response to country-specific labour demand shocks that cause stronger and more persistent reactions of the employment and the participation rate. However, we detect a convergence of the adjustment processes in Europe and the US, reflecting both a fall in interstate migration in the US and a rise in the role of migration in Europe. Finally, we show that part of the difference between Europe and the US in previous studies may be due to the use of different data sources.
JEL Code
F2 : International Economics→International Factor Movements and International Business
J6 : Labor and Demographic Economics→Mobility, Unemployment, Vacancies, and Immigrant Workers
R23 : Urban, Rural, Regional, Real Estate, and Transportation Economics→Household Analysis→Regional Migration, Regional Labor Markets, Population, Neighborhood Characteristics
R30 : Urban, Rural, Regional, Real Estate, and Transportation Economics→Real Estate Markets, Spatial Production Analysis, and Firm Location→General
5 August 2013
WORKING PAPER SERIES - No. 1571
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Abstract
This paper analyses the real-time forecasting performance of the New Keynesian DSGE model of Galí, Smets, and Wouters (2012) estimated on euro area data. It investigates to what extent forecasts of inflation, GDP growth and unemployment by professional forecasters improve the forecasting performance. We consider two approaches for conditioning on such information. Under the “noise” approach, the mean professional forecasts are assumed to be noisy indicators of the rational expectations forecasts implied by the DSGE model. Under the “news” approach, it is assumed that the forecasts reveal the presence of expected future structural shocks in line with those estimated over the past. The forecasts of the DSGE model are compared with those from a Bayesian VAR model and a random walk.
JEL Code
E24 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
15 February 2013
WORKING PAPER SERIES - No. 1514
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Abstract
The empirical literature on systemic banking crises (SBCs) has shown that SBCs are rare events that break out in the midst of credit intensive booms and bring about particularly deep and long-lasting recessions. We attempt to explain these phenomena within a dynamic general equilibrium model featuring a non-trivial banking sector. In the model, banks are heterogeneous with respect to their intermediation skills, which gives rise to an interbank market. Moral hazard and asymmetric information on this market may generate sudden interbank market freezes, SBCs, credit crunches and, ultimately, severe recessions. Simulations of a calibrated version of the model indicate that typical SBCs break out in the midst of a credit boom generated by a sequence of positive supply shocks rather than being the outcome of a big negative wealth shock. We also show that the model can account for the relative severity of recessions with SBCs and their longer duration.
JEL Code
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
Network
Macroprudential Research Network
2 May 2011
WORKING PAPER SERIES - No. 1336
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Abstract
We evaluate the ECB's monetary policy strategy against the underlying economic structure of the euro area economy, in normal times and in times of severe financial dislocations. We show that in the years preceding the financial crisis that started in 2007 the strategy was successful at ensuring macroeconomic stability and steady growth despite shocks to the supply side and to the transmission mechanism which complicated the policy process. Emphasis on monetary indicators in the ECB's monetary policy strategy
JEL Code
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
23 February 2010
WORKING PAPER SERIES - No. 1153
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Abstract
This paper uses information from a rich firm-level survey on wage and price-setting procedures, in around 15,000 firms in 15 European Union countries, to investigate the relative importance of internal versus external factors in the setting of wages of newly hired workers. The evidence suggests that external labour market conditions are less important than internal pay structures in determining hiring pay, with internal pay structures binding even more often when there is labour market slack. When explaining their choice firms allude to fairness considerations and the need to prevent a potential negative impact on effort. Despite the lower importance of external factors in all countries there is significant cross-country variation in this respect. Cross-country differences are found to depend on institutional factors (bargaining structures); countries in which collective agreements are more prevalent and collective agreement coverage is higher report to a greater extent internal pay structures as the main determinant of hiring pay. Within-country differences are found to depend on firm and workforce characteristics; there is a strong association between the use of external factors in hiring pay, on the one hand, and skills (positive) and tenure (negative) on the other.
JEL Code
J31 : Labor and Demographic Economics→Wages, Compensation, and Labor Costs→Wage Level and Structure, Wage Differentials
J41 : Labor and Demographic Economics→Particular Labor Markets→Labor Contracts
Network
Wage dynamics network
12 November 2008
WORKING PAPER SERIES - No. 960
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Abstract
We review the recent literature that studies new, detailed micro data on prices. We discuss implications of the new micro data for macro models. We argue that the new micro data are helpful for macro models, but not decisive. There is no simple mapping from the frequency of price changes in micro data to impulse responses of prices and quantities to shocks. We discuss ideas that promise to deliver macro models matching the impulse responses seen in macro data while being broadly in line with micro data.
JEL Code
E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles
E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
30 April 2008
WORKING PAPER SERIES - No. 891
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Abstract
This paper estimates a Bayesian VAR for the US economy which includes a housing sector and addresses the following questions. Can developments in the housing sector be explained on the basis of developments in real and nominal GDP and interest rates? What are the effects of housing demand shocks on the economy? How does monetary policy affect the housing market? What are the implications of house price developments for the stance of monetary policy? Regarding the latter question, we implement a version of a Monetary Conditions Index (MCI) due to Céspedes et al. (2006).
JEL Code
E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles
E4 : Macroeconomics and Monetary Economics→Money and Interest Rates
31 March 2008
WORKING PAPER SERIES - No. 884
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Abstract
The objective of this paper is to examine the main features of optimal monetary policy cooperation within a micro-founded macroeconometric framework. First, using Bayesian techniques, we estimate a two-country dynamic stochastic general equilibrium (DSGE) model for the United States (US) and the euro area (EA). The main features of the new open economy macroeconomics (NOEM) are embodied in our framework: in particular, imperfect exchange rate pass-through and incomplete financial markets internationally. Each country model incorporates the wide range of nominal and real frictions found in the closed-economy literature: staggered price and wage settings, variable capital utilization and fixed costs in production. Then, using the estimated parameters and disturbances, we study the properties of the optimal monetary policy cooperation through welfare analysis, impulse responses and variance decompositions.
JEL Code
E4 : Macroeconomics and Monetary Economics→Money and Interest Rates
E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
F4 : International Economics→Macroeconomic Aspects of International Trade and Finance
31 January 2008
WORKING PAPER SERIES - No. 858
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Abstract
We use a version of the New Area-Wide Model (NAWM) developed at the ECB in order to quantify the gains from monetary policy cooperation. The model is calibrated in order to match a set of empirical moments. We then derive the cooperative and (open-loop) Nash monetary policies, assuming that the central banks' objectives is to maximize the welfare of the households. Our results show that given the current degree of openness of the US and euro area economies, the gains from monetary policy coordination are small, amounting to 0.03 percent of steady-state consumption. Nevertheless, the gains appear to be sensitive to the degree of openness and further economic integration between the two regions could generate sizable gains from cooperation. For example, increasing the trade shares to 32 percent of GDP in both regions, the gains from cooperation rise to about 1 percent of steady-state consumption. By decomposing the sources of the gains from cooperation with respect to the various shocks, we show that mark-up shocks are the most important source for gains from international monetary policy cooperation.
JEL Code
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
F42 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Policy Coordination and Transmission
23 October 2007
WORKING PAPER SERIES - No. 818
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Abstract
In the paper, we provide a critical and selective survey of arguments relevant for the assessment of the case for price level path stability (PLPS). Using a standard hybrid new Keynesian model we argue that price level stability provides a natural framework for monetary policy under commitment. There are two main arguments in favour of a PLPS regime. First, it helps overall macroeconomic stability by making expectations operate like automatic stabilizers. Second, under a price level path stability regime, changes in the price level operate like an intertemporal adjustment mechanism, reducing the magnitude of required changes in nominal interest rates. Such a property is particularly relevant as a means to alleviate the importance of the zero bound on nominal interest rates. We also review and discuss the arguments against price level path stability. Finally, we also found, using the Smets and Wouters (2003) model which includes a wide variety of frictions and is estimated for the euro area, that the price level is stationary under optimal policy under commitment. The results obtain when the quasi-difference of inflation is used in the loss function, as in the hybrid new Keynesian model. Overall, the arguments in favour of or against price level path stability depend on the degree of dependence of private sector expectations on the characteristics of the monetary policy regime.
JEL Code
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
D83 : Microeconomics→Information, Knowledge, and Uncertainty→Search, Learning, Information and Knowledge, Communication, Belief
6 February 2007
WORKING PAPER SERIES - No. 722
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Abstract
Using a Bayesian likelihood approach, we estimate a dynamic stochastic general equilibrium model for the US economy using seven macro-economic time series. The model incorporates many types of real and nominal frictions and seven types of structural shocks. We show that this model is able to compete with Bayesian Vector Autoregression models in out-of-sample prediction. We investigate the relative empirical importance of the various frictions. Finally, using the estimated model we address a number of key issues in business cycle analysis: What are the sources of business cycle fluctuations? Can the model explain the cross-correlation between output and inflation? What are the effects of productivity on hours worked? What are the sources of the "Great Moderation"?
JEL Code
E4 : Macroeconomics and Monetary Economics→Money and Interest Rates
E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
25 January 2007
WORKING PAPER SERIES - No. 719
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Abstract
This paper investigates the role of three likely factors in driving the steady deterioration of the US external balance: US technology developments, changes in the US government fiscal position and the Fed's monetary policy. Estimating several Vector Autoregressions on US data over the period 1982:2 to 2005:4 we identify five structural shocks: a multi-factor productivity shock; an investment-specific technology shock; a monetary policy shock; and a fiscal revenue and spending shock. Together these shocks can account for the deterioration and subsequent reversal of the trade balance in the 1980s. Productivity improvements and fiscal and monetary policy easing also play an important role in the increase of the external deficit since 2000, but these structural shocks can not explain why the trade balance deteriorated in the second half of the 1990s.
JEL Code
F3 : International Economics→International Finance
F4 : International Economics→Macroeconomic Aspects of International Trade and Finance
28 June 2006
WORKING PAPER SERIES - No. 648
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Abstract
This paper compares the Calvo model with a Taylor contracting model in the context of the Smets-Wouters (2003) Dynamic Stochastic General Equilibrium (DSGE) model. In the Taylor price setting model, we introduce firm-specific production factors and discuss how this assumption can help to reduce the estimated nominal price stickiness. Furthermore, we show that a Taylor contracting model with firm-specific capital and sticky wage and with a relatively short price contract length of four quarters is able to outperform, in terms of empirical fit, the standard Calvo model with homogeneous production factors and high nominal price stickiness. In order to obtain this result, we need very large real rigidities either in the form of a huge (constant) elasticity of substitution between goods or in the form of an elasticity of substitution that is endogenous and very sensitive to the relative price.
JEL Code
E1 : Macroeconomics and Monetary Economics→General Aggregative Models
E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles
26 June 2006
WORKING PAPER SERIES - No. 644
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Abstract
We show that, when private sector expectations are determined in line with adaptive learning, optimal policy responds persistently to cost-push shocks. The optimal response is stronger and more persistent, the higher is the initial level of perceived inflation persistence by the private sector. Such a sophisticated policy reduces inflation persistence and inflation volatility at little cost in terms of output gap volatility. Persistent responses to cost-push shocks and stability of inflation expectations resemble optimal policy under commitment and rational expectations. Nevertheless, it is clear that the mechanism at play is very different. In the case of commitment it relies on expectations of future policy actions affecting inflation expectations; in the case of sophisticated central banking it relies on the reduction in the estimated inflation persistence parameter based on inflation data generated by shocks and policy responses.
JEL Code
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
1 June 2006
OCCASIONAL PAPER SERIES - No. 46
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Abstract
This paper provides a summary of current knowledge on inflation persistence and price stickiness in the euro area, based on research findings that have been produced in the context of the Inflation Persistence Network. The main findings are: i) Under the current monetary policy regime, the estimated degree of inflation persistence in the euro area is moderate; ii) Retail prices in the euro area are more sticky than in the US; iii) There is significant sectoral heterogeneity in the degree of price stickiness; iv) Price decreases are not uncommon. The paper also investigates some of the policy implications of these findings.
JEL Code
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E42 : Macroeconomics and Monetary Economics→Money and Interest Rates→Monetary Systems, Standards, Regimes, Government and the Monetary System, Payment Systems
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
1 June 2005
WORKING PAPER SERIES - No. 491
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Abstract
The paper provides new tools for the evaluation of DSGE models, and applies it to a large-scale New Keynesian dynamic stochastic general equilibrium (DSGE) model with price and wage stickiness and capital accumulation. Specifically, we approximate the DSGE model by a vector autoregression (VAR), and then systematically relax the implied cross-equation restrictions. Let λ denote the extent to which the restrictions are being relaxed. We document how the in- and out-of sample fit of the resulting specification (DSGE-VAR) changes as a function of λ. Furthermore, we learn about the precise nature of the misspecification by comparing the DSGE model's impulse responses to structural shocks with those of the best-fitting DSGE-VAR. We find that the degree of misspecification in large-scale DSGE models is no longer so large to prevent their use in day-to-day policy analysis, yet it is not small enough that it cannot be ignored.
JEL Code
C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General
C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods
29 September 2004
WORKING PAPER SERIES - No. 391
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Abstract
This paper estimates a DSGE model with many types of shocks and frictions for both the US and the euro area economy over a common sample period (1974-2002). The structural estimation methodology allows us to investigate whether differences in business cycle behaviour are due to differences in the type of shocks that affect the two economies, differences in the propagation mechanism of those shocks or differences in the way the central bank responds to those economic developments. Our main conclusion is that each of those characteristics is remarkably similar across both currency areas.
JEL Code
E1 : Macroeconomics and Monetary Economics→General Aggregative Models
E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles
14 September 2004
WORKING PAPER SERIES - No. 389
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Abstract
In monetary policy strategies geared towards maintaining price stability conditional and unconditional forecasts of inflation and output play an important role. This paper illustrates how modern sticky-price dynamic stochastic general equilibrium models, estimated using Bayesian techniques, can become an additional useful tool in the forecasting kit of central banks. First, we show that the forecasting performance of such models compares well with a-theoretical vector autoregressions. Moreover, we illustrate how the posterior distribution of the model can be used to calculate the complete distribution of the forecast, as well as various inflation risk measures that have been proposed in the literature. Finally, the structural nature of the model allows computing forecasts conditional on a policy path. It also allows examining the structural sources of the forecast errors and their implications for monetary policy. Using those tools, we analyse macroeconomic developments in the euro area since the start of EMU.
JEL Code
E4 : Macroeconomics and Monetary Economics→Money and Interest Rates
E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
28 May 2004
WORKING PAPER SERIES - No. 364
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Abstract
The paper aims at deriving some stylised facts for financial, real, and monetary policy developments during asset price booms by means of aggregating information contained in 38 boom periods since the 1970s for 18 OECD countries. We observe 26 macroeconomic variables in a pre-boom, boom and post-boom phase. Not all booms lead to large output losses. We divide our sample in high-cost and low-cost booms and analyse the differences. High-cost booms are clearly those in which real estate prices and investment crash in the post-boom periods. In general it is difficult to distinguish a high-cost from a low-cost boom at an early stage. However, high-cost booms seem to follow very rapid growth in the real money and real credit stocks just before the boom and at the early stages of a boom. During high-cost booms, rates of change of real estate prices and consumption growth are significantly higher and the investment (especially housing) GDP ratio deviation from trend rises faster over the whole boom period. There is also evidence that high-cost booms are associated with significantly looser monetary policy conditions over the boom period, especially towards the late stage of a boom. We finally discuss the results with regard to the theoretical literature. The looser monetary policy at the later stage of high-cost booms could be interpreted in different ways. It could be that excessively loose monetary policy contributes to extending the boom and exacerbating the real and financial imbalances. Alternatively, observed monetary policy could reflect a desirable, pre-emptive loosening in anticipation of an asset price crash to come.
JEL Code
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
1 August 2003
WORKING PAPER SERIES - No. 250
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Abstract
In this paper we first explore the impact of nominal and real persistence on the transmission process of various shocks in an estimated DSGE model of euro area. We then analyse its impact on optimal monetary policy and investigate the performance of various monetary policies when the policy maker is uncertain about the degree of nominal and real persistence.
JEL Code
E4 : Macroeconomics and Monetary Economics→Money and Interest Rates
E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
1 August 2002
WORKING PAPER SERIES - No. 171
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Abstract
This paper develops and estimates a stochastic dynamic general equilibrium (SDGE) model with sticky prices and wages for the euro area. The model incorporates various other features such as habit formation, costs of adjustment in capital accumulation and variable capacity utilisation. It is estimated with Bayesian techniques using seven key macro-economic variables: GDP, consumption, investment, prices, real wages, employment and the nominal interest rate. The introduction of ten orthogonal structural shocks (including productivity, labour supply, investment, preference, cost-push and monetary policy shocks) allows for an empirical investigation of the effects of such shocks and of their contribution to business cycle fluctuations in the euro area. Using the estimated model, the paper also analyses the output (real interest rate) gap, defined as the difference between the actual and model-based potential output (real interest rate).
JEL Code
E4 : Macroeconomics and Monetary Economics→Money and Interest Rates
E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
Network
International Seminar on Macroeconomics
1 August 2002
WORKING PAPER SERIES - No. 165
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Abstract
We first estimate the effects of an euro area-wide monetary policy change on output growth in eleven industries of seven euro area countries over the period 1980-1998. On average the negative effect of an interest rate tightening on output is significantly greater in recessions than in booms. There is, however, considerable cross-industry heterogeneity in both the overall policy effects and the degree of asymmetry across the two business cycle phases. We then explore which industry characteristics can account for this cross-industry heterogeneity. Differences in the overall policy effects can mainly be explained by the durability of the goods produced in the sector. In contrast, differences in the degree of asymmetry of policy effects seem to be related to differences in financial structure, in particular the maturity structure of debt, the coverage ratio, financial leverage and firm size.
JEL Code
E4 : Macroeconomics and Monetary Economics→Money and Interest Rates
E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
1 July 2002
WORKING PAPER SERIES - No. 160
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Abstract
On the basis of historical data aggregated over the period 1973 to 2000, we estimated four different equilibrium exchange rate models for the synthetic euro. Using the same data set, variable definitions and sample period offers the possibility to assess the uncertainty surrounding such equilibrium levels, both from a statistical and a theoretical perspective. We employed reduced form co-integration models, a structurla VAR, a Natrex model (estimated in structural form) and the ECB's small-sized euro area wide macro-economic model. In this order the approaches feature an increasing degree of 'structure', in the sense of the constraints based on economic theory embedded in the econometric models that were estimated. The results confirm the high leikelihood for the euro ahving been undervalued in Q4 2000, while stressing the significant empirical and theoretical uncertainty with respect to the equilibrium exchange rate level.
JEL Code
F31 : International Economics→International Finance→Foreign Exchange
F32 : International Economics→International Finance→Current Account Adjustment, Short-Term Capital Movements
1 February 2002
WORKING PAPER SERIES - No. 128
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Abstract
This paper analyses the implications of imperfect exchange rate pass-through for optimal monetary policy in a linearised open-economy dynamic general equilibrium model calibrated to euro area data. Imperfect exchange rate pass through is modelled by assuming sticky import price behaviour. The degree of domestic and import price stickiness is estimated by reproducing the empirical identified impulse response of a monetary policy and exchange rate shock conditional on the response of output, net trade and the exchange rate. It is shown that a central bank that wants to minimise the resource costs of staggered price setting will aim at minimising a weighted average of domestic and import price inflation.
JEL Code
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
1 December 2001
WORKING PAPER SERIES - No. 91
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Abstract
This paper applies the identified VAR methodology to synthetic euro area data from 1980 till 1998 to study the macro-economic effects of an unexpected change in monetary policy in the euro area. The focus is on the area-wide monetary transmission. It is shown that the overall macro-economic effects of a monetary policy shock in the euro area are very similar to those estimated for the United States and are surprisingly stable over time. In addition, the paper contains a number of robustness checks with alternative identification schemes and examines how various real and financial variables (such as the GDP or money components) respond to an area-wide monetary policy impulse
JEL Code
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
Network
Eurosystem Monetary Transmission Network
1 October 2001
WORKING PAPER SERIES - No. 78
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Abstract
This paper analyses the effects of a change in monetary policy on firms' investment in Germany, France, Italy and Spain using a data set which provides aggregated balance sheet and profit and loss account data for 17 different industries and 3 different size classes. The main findings are twofold. First, in each of the four countries a change in the user cost of capital, which in turn is affected by interest rates, has both statistically and economically significant effects on investment. Second, while the average interest rate on debt is generally higher for small firms than for large firms, there is little evidence that the effects of monetary policy on small firms are larger
JEL Code
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
1 April 2001
WORKING PAPER SERIES - No. 59
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Abstract
This paper uses a small, calibrated forward-looking model of the euro-area economy to investigate the implications of incomplete information about potential output for the conduct and the design of monetary policy. Three sets of issues are examined. First, the certainty-equivalent optimal policy under both commitment and discretion is characterised. In both cases, incomplete information about potential output leads to very persistent deviations between the actual and the perceived output gap in response to supply and cost-push shocks. The costs of imperfect information are quite large. Second, the implications for simple policy rules such as Taylor or inflation-forecast rule are examined. In first-difference form, both rules continue to perform relatively well with imperfect information as long as the output gap and the inflation forecast are optimally estimated. Third, the implications of potential output uncertainty for the optimal delegation to an independent central bank are examined. Incomplete information implies that it is optimal to appoint a more 'hawkish' central bank.
JEL Code
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E17 : Macroeconomics and Monetary Economics→General Aggregative Models→Forecasting and Simulation: Models and Applications
1 March 2001
WORKING PAPER SERIES - No. 52
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Abstract
This paper investigates whether monetary policy impulses have asymmetric effects on output growth in seven countries of the euro area (Germany, France, Italy, Spain, Austria, Belgium and the Netherlands). First, it is shown that these seven countries share the same business cycle. Next, strong evidence is presented that area-wide monetary policy impulses, measured as the contribution of monetary policy shocks to the short-term interest rate in a simple VAR for the euro area economy, have significantly larger effects on output growth in recessions than in booms. These differences are most pronounced in Germany, France, Italy, Spain, and Belgium, while they are much smaller in Austria and the Netherlands
JEL Code
E4 : Macroeconomics and Monetary Economics→Money and Interest Rates
E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
1 July 2000
WORKING PAPER SERIES - No. 24
Details
Abstract
This paper analyses in a unified framework the twin issues of the appropriate horizon for achieving price stability in the face of unexpected disturbances and the choice of a price level versus an inflation objective. Using a small estimated forward-looking model of the euro area economy, the three main findings are: 1) The policy horizon becomes shorter the greater the weight on price stability in society's objective function, the higher the degree of 'forward-lookingness' in the economy and the greater the slope of the Phillips curve; 2) The optimal policy horizon for a price level objective is generally greater than that for an inflation objective; 3) Even if society cares about inflation stabilisation (rather than the stabilisation of the price level), it often pays to give the central bank a price level objective (rather than an inflation objective), provided the horizon is optimally chosen to be somewhat longer and there is a small weight on interest rate stabilisation in the loss function. This result depends, however, on the structure of the economy.
JEL Code
E4 : Macroeconomics and Monetary Economics→Money and Interest Rates
E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit