The economic consequences of euro-area macro-modelling shortcuts

Abstract

Should euro-area economies be modelled in an aggregate (area-wide) fashion or in a disaggregate (multi-country) one? This article tackles that question from both statistical and economic viewpoint. From a statistical viewpoint, aggregation bias criteria are found to signal that the degree of structural heterogeneity among euro-area economies is such that the loss of information entailed by an aggregate modelling approach may be far from trifling. From an economic viewpoint, we investigate the following issue. Are those statistically detectable heterogeneities of any practical relevance when it comes to supporting monetary policy decision-making? To provide an answer to this question, we compute simple optimal monetary policy reaction functions on the basis of either an aggregate model or a disaggregate one, and compare the associated welfare losses. The results suggest that the welfare under-performance of an area-wide-model-based rule is not only nonnegligible, but also robust with respect to a number of sensitivity analyses.

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