The monetary transmission mechanism in the euro area: evidence from VAR analysis

Abstract

Introduction There is a large literature that has used identified Vector Autoregressions (VARs) to study the macroeconomic effects of an unexpected change in policy-controlled interest rates in the euro area countries. The use of VARs for the analysis of monetary policy started with the seminal work of Sims (1980). Christiano, Eichenbaum and Evans (1999) and Leeper, Sims and Zha (1998) have reviewed what one has learned from this extensive literature regarding the monetary transmission mechanism in the USA. A large part of the literature on the euro area has focused on trying to identify cross-country differences. In these studies, VARs are estimated for the individual countries of the euro area, and the impulse responses of the main macroeconomic variables to a monetary policy shock are compared. The focus of this chapter is on what we can learn regarding the area-wide monetary transmission from analysing a VAR estimated on synthetic euro area data from 1980 to 1998. In section 2, we show that using a standard identification scheme as in Christiano, Eichenbaum and Evans (1999) and Eichenbaum and Evans (1995) delivers plausible estimates of the effects of monetary policy in the euro area. An unexpected, temporary rise in the short-term interest rate tends to be followed by a real appreciation of the exchange rate and a temporary fall in output after two quarters. The effect on output reaches a peak after three–five quarters, after which it slowly returns to the baseline.

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