Macroeconomic dynamics in the euro area (original) (raw)

2008, NBER Macroeconomics Annual

This paper characterizes the transmission mechanism of monetary and oil-price shocks across countries of the euro area, documents how this mechanism has changed with the introduction of the euro, and explores some potential explanations. The factor-augmented VAR (FAVAR) framework used is su¢ ciently rich to jointly model the euro area dynamics while permitting the transmission of shocks to be di¤erent across countries. We …nd important heterogeneity across countries in the e¤ect of macroeconomic shocks before the launch of the euro. In particular, we …nd that German interest-rate shocks triggered stronger responses of interest rates and consumption in some countries such as Italy and Spain, than in Germany itself. According to our estimates, the creation of the euro has contributed 1) to a greater homogeneity of the transmission mechanisms across countries, and 2) to an overall reduction in the e¤ects of this shock. Using a structural open-economy model, we argue that the combination of a change in the policy reaction function -mainly toward a more aggressive response to in ‡ation and output -and the elimination of an exchange rate risk can explain the evolution of the monetary transmission mechanism observed empirically.

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