Differences in labour market institutions and regulations between countries of the monetary union can cause divergent responses even to a common shock. We augment a multi-country model of the euro area with search and matching framework that differs across Ricardian and hand-to-mouth households. In this setting, we investigate the implications of cross-country heterogeneity in labour market institutions for the conduct of monetary policy in a monetary union. We compute responses to demand and supply shocks under the Taylor rule, asymmetric unemployment targeting, and average inflation targeting. For each rule we distinguish between cases with lower or higher weight on the unemployment gap. Across all rules, responding to unemployment leads to lower losses of employment. Responding to unemployment reduces cross-country differences within the monetary union and consumption inequality between rich and poor households within each country.

In the low inflation and low interest rate environment that prevailed over the period 2013-2020, many argued that besides expansionary monetary policy, expansionary fiscal policy could also support central banks’ efforts to bring inflation closer to target. During the pandemic, proper alignment of fiscal and monetary policy was again crucial in promoting a rapid macroeconomic recovery. Since the end of 2021 an environment of higher inflation, lower growth, higher uncertainty, and higher interest rates has changed the nature of the required policy mix and poses different challenges to the interaction between monetary and fiscal policy. Following up on the work done under the ECB’s 2020 strategy review (see Debrun et al., 2021), this report explores some of the renewed challenges to monetary and fiscal policy interactions in an environment of high inflation. The main general conclusion is that, with an independent monetary policy that aims to bring inflation back to target in a timely manner, it is still possible to design fiscal policy in a way that protects vulnerable parts of society against the costs of high inflation without pulling against the central bank’s effort to tame inflation. This is more likely to be the case if fiscal measures are temporary and targeted, and if priority is given to structural reforms and public investment in support of potential growth. The latter is particularly effective in reshaping the supply side of the economy in a manner that is likely to have a lasting positive structural impact.

Differences in labour market institutions and regulations between countries of the monetary union can cause divergent responses even to a common shock. We augment a multi - country model of the euro area with search and matching framework that differs across Ricardian and hand - to - mouth households. In this setting, we investigate the implications of cross - country heterogeneity in labour market institutions for the conduct of monetary policy in a monetary union. We compute responses to an expansionary demand shock and to an inflationary supply shock under a standard Taylor rule, asymmetric unemployment targeting, and average inflation targeting. For each rule we distinguish between cases with zero weight on the unemployment gap and a negative response to rising unemployment. Across all rules, responding to unemployment leads to lower losses of employment and higher inflation. Responding to unemployment reduces cross - country differences within the monetary union and the differences in consumption levels of Ricardian and hand - to - mouth households.

The ECB’s price stability mandate has been defined by the Treaty. But the Treaty has not spelled out what price stability precisely means. To make the mandate operational, the Governing Council has provided a quantitative definition in 1998 and a clarification in 2003. The landscape has changed notably compared to the time the strategy review was originally designed. At the time, the main concern of the Governing Council was to anchor inflation at low levels in face of the inflationary history of the previous decades. Over the last decade economic conditions have changed dramatically: the persistent low-inflation environment has created the concrete risk of de-anchoring of longer-term inflation expectations. Addressing low inflation is different from addressing high inflation. The ability of the ECB (and central banks globally) to provide the necessary accommodation to maintain price stability has been tested by the lower bound on nominal interest rates in the context of the secular decline in the equilibrium real interest rate. Against this backdrop, this report analyses: the ECB’s performance as measured against its formulation of price stability; whether it is possible to identify a preferred level of steady-state inflation on the basis of optimality considerations; advantages and disadvantages of formulating the objective in terms of a focal point or a range, or having both; whether the medium-term orientation of the ECB’s policy can serve as a mechanism to cater for other considerations; how to strengthen, in the presence of the lower bound, the ECB’s leverage on private-sector expectations for inflation and the ECB’s future policy actions so that expectations can act as ‘automatic stabilisers’ and work alongside the central bank.

This report discusses the role of the European Union’s full employment objective in the conduct of the ECB’s monetary policy. It first reviews a range of indicators of full employment, highlights the heterogeneity of labour market outcomes within different groups in the population and across countries, and documents the flatness of the Phillips curve in the euro area. In this context, it is stressed that labour market structures and trend labour market outcomes are primarily determined by national economic policies. The report then recalls that, in many circumstances, inflation and employment move together and pursuing price stability is conducive to supporting employment. However, in response to economic shocks that give rise to a temporary trade-off between employment and inflation stabilisation, the ECB’s medium-term orientation in pursuing price stability is shown to provide flexibility to contribute to the achievement of the EU’s full employment objective. Regarding the conduct of monetary policy in a low interest rate environment, model-based simulations suggest that history-dependent policy approaches − which have been proposed to overcome lasting shortfalls of inflation due to the effective lower bound on nominal interest rates by a more persistent policy response to disinflationary shocks − can help to bring employment closer to full employment, even though their effectiveness depends on the strength of the postulated expectations channels. Finally, the importance of employment income and wealth inequality in the transmission of monetary policy strengthens the case for more persistent or forceful easing policies (in pursuit of price stability) when interest rates are constrained by their lower bound.

We evaluate the macroeconomic effects of changes in loan-to-value ratios in a multi-country model with financial frictions and a banking sector. Main findings suggest that a permanent LTV tightening in a small euro area economy leads to a long-run decline in lending to the private sector. The short-run impact depends crucially on the policy design, being less pronounced when the measure is phased-in. This is consistent with policy goals of curbing credit growth but avoiding an abrupt immediate contraction. A euro area wide measure implies larger long-run effects but the short-run recessionary impact is attenuated by the monetary policy response.

We incorporate financial linkages in EAGLE, a New Keynesian multi-country dynamic general equilibrium model of the euro area (EA) by including financial frictions and country-specific banking sectors. In this new version, termed EAGLE-FLI (Euro Area and GLobal Economy with Financial LInkages), banks collect deposits from domestic households and cross-country inter-bank market and raise capital to finance loans issued to domestic households and firms. In order to borrow from local (regional) banks, households use domestic real estate whereas firms use both domestic real estate and physical capital as collateral. These features – together with the full characterization of trade balance and real exchange rate dynamics and with a rich array of financial shocks – allow to properly assessing domestic and cross-country macroeconomic effects of financial shocks. Our results support the views that (1) the business cycles in the EA can be driven not only by real shocks, but also by financial shocks, (2) the financial sector could amplify the transmission of (real) shocks, and (3) the financial/banking shocks and the banking sectors can be sources of business cycle asymmetries and spillovers across countries in a monetary union.

The global financial crisis and the sovereign debt crisis brought back to the policy debate the issue of the lower bound (LB) on interest rates and the policy options when this is a binding constraint. The paper looks at structural reforms as a way to provide economic stimulus for an economy at the LB. We focus on the euro area and carry out a comprehensive analysis within a multi-country structural model of the euro area within the world. Main results show structural reforms have positive short-run effects that reduce the size of a recession and in some cases can drive the euro area out of the LB. The labor reform accentuates deflation which implies that interest rates remain at the LB for the same number of periods, while the services reform pushes the euro area out of the LB if implemented in the largest part of the union. The latter result hinges on the assumption of a gradual implementation of reforms. Reforms have significantly different effects across different types of households and thus the share of these households is important in the transmission. Unilateral reforms in a large bloc have positive spillover effects within the euro area. Unilateral reforms in a small bloc are deflationary but the small size of the bloc leads to very limited impact of national developments on monetary policy. (C) 2017 Elsevier Inc. All rights reserved.

We assess the role of monetary policy news shocks in the context of a medium scale DSGE model estimated on US data. We estimate several versions of the model and find decisive evidence in favour of the inclusion of monetary policy news shocks over a two-quarter horizon. According to our results, monetary policy news shocks account for a non-negligible fraction of the variance of real variables, especially at shorter forecast horizons. Further, we document that the importance of monetary policy news shocks goes beyond what was observed in recent years. The historical importance of monetary policy news shocks dates back to the 1999–2006 period when the official FOMC statements provided information about both the current policy setting and the expected future policy path. We also show that adding monetary policy news shocks to the model does not lead to identification problems.

This paper explores the link between agent expectations and housing market dynamics. We focus on shifts in the fundamental driving forces of the economy that are anticipated by rational forward-looking agents, i.e. news shocks. Using Bayesian methods and U.S. data, we find that news-shock-driven-cycles account for a sizable fraction of the variability in house prices and other macroeconomic variables over the business cycle and have also contributed to run-ups in house prices over the last three decades. By exploring the link between news shocks and agent expectations, we show that house price growth was positively related to inflation expectations during the boom of the late 1970’s but negatively related to interest rate expectations during the mid-2000’s housing boom.

This paper analyses whether fiscal policies can alleviate the effects of a global recession that drives interest rates to the zero lower bound. Additionally, we study the benefits of international coordination. The analysis is carried out using a dynamic general equilibrium model of the global economy (EAGLE model). We consider that the fiscal shocks are temporary and that fiscal policy retains full credibility at all times. In this setup we find significant non-linearities in a zero lower bound situation that amplify the effects of fiscal shocks compared to the non-zero lower bound case. International coordination is helpful but does not play a major role in the results.

We assess the effects of a temporary fiscal devaluation enacted in Spain on the trade balance by simulating EAGLE, a large-scale multi-country dynamic general equilibrium model of the euro area. Social contributions paid by firms are reduced by 1% of GDP for four years and are financed by increasing the consumption tax. Our main results are the following. First, in the first years following implementation the Spanish trade balance improves by around 0.6% of GDP, the (before-consumption tax) real exchange rate depreciates by 0.7% and the terms of trade deteriorate by 1.3%. Second, the trade balance improves when the temporary fiscal devaluation is also enacted in the rest of the euro area, albeit to a lower extent than in the case of unilateral (country-specific) implementation. Third, similar results are obtained if we consider the case of a smaller euro area economy, specifically Portugal. Fourth, quantitative results are robust to changes in some key parameters but crucially depend on the degree of substitutability between domestic and imported tradables.

We augment a medium-scale DSGE model with monetary policy news shocks and t it to US data. Monetary policy news shocks improve the performance of the model both in terms of marginal data density and in terms of its ability to match the empirical moments of the variables used as observables. We estimate several versions of the model and nd that the one with news shocks over a two-quarter horizon dominates in terms of overall goodness of t. We show that, in the estimated model: (1) adding monetary policy news shocks to the model does not lead to identi cation problems; (2) monetary policy news shocks account for a larger fraction of the unconditional variance of the observables than the standard unanticipated monetary policy shock; (3) these news shocks also help to achieve a better matching of the covariances of consumption growth and the interest rate.

The onset of the financial crisis in 2008 has highlighted the problems of diverging external imbalances within Economic and Monetary Union (EMU) and the role of persistent losses in competitiveness. This paper starts by investigating some of the competitiveness factors which contributed to external imbalances in euro area countries. The evidence suggests significant heterogeneity across countries in both price/cost and non-price competitiveness in the euro area and that there is no one factor, but rather a range of potential factors explaining diverging external imbalances. In particular, while non-price competitiveness effects contributed largely to the trade surplus in some countries, for some southern European countries the trade balance was also driven by price factors. The second part of the paper studies the implications of competitiveness adjustment by means of quantitative tools. Using four different multi-country macro models, improvements in both price/cost aspects (namely wage reduction, productivity improvements or fiscal devaluation) and non-price competitiveness factors (quality improvements) were shown – under certain conditions – to improve external imbalances. The analysis suggests differences in countries’ composition of trade could lead to heterogeneity in the potential gains from improvements in competitiveness.

The recent financial crisis is likely to have damaged the potential output of many countries belonging to the euro area. Moreover, the heterogeneity in long-run macroeconomic performance among Member States may not be sustainable in the presence of strong monetary and financial integration, thus suggesting the need for coordinating structural reforms. Using a multi-country dynamic general equilibrium model of the euro area, we assess the macroeconomic effects of increasing competition in the labour and services markets in Germany and the rest of the euro area and, in an alternative scenario, Portugal and the rest of the euro area. Our main results suggest that (i) a unilateral increase in competition in the labour and services markets would increase long-run output; and that (ii) cross-country coordination would make the macroeconomic performance of the different regions more homogeneous, in terms of both price competitiveness and of real activity.

Building on the New Area Wide Model, we develop a 4-region macroeconomic model of the euro area and the world economy. The model (EAGLE, Euro Area and Global Economy model) is microfounded and designed for conducting quantitative policy analysis of macroeconomic interdependence across regions belonging to the euro area and between euro area regions and the world economy. Simulation analysis shows the transmission mechanism of region-specific or common shocks, originating in the euro area and abroad.

The fact that nominal interest rates cannot be negative implies that alternative policies must be considered at the zero bound to provide stimulus, should it be needed. This note is an assessment of fi scal policies at the zero bound. Using a model for the euro area, we illustrate and quantify the effects of fi scal policy responses to a major recession that leads the economy to the zero lower bound on interest rates. First, we show that ad-hoc fi scal policy measures lead to results that are very different from the effi cient allocation. Then, drawing on the results in Correia, Farhi, Nicolini and Teles (2011), we show how fi scal policy should be designed to replicate the effi cient allocation.

This article analyses the response of a set of euro area macroeconomic variables to monetary policy and technology shocks based on structural Vector Auto-regressions (VARs). The data set runs from 1970:1 until 2006:4 and includes a novel long-run series for hours worked per capita in the euro area. We find that real macroeconomic variables follow a hump-shaped response after monetary policy shocks and jump on impact after technology shocks. We also provide evidence that hours worked fall after a positive technology shock. These conclusions are robust to different sample periods and specifications of the variables.