A Two-Pillar DSGE Monetary Policy Model for the Euro Area
41 Pages Posted: 21 Sep 2010
Date Written: July 2008
Whereas the bulk of the literature on DSGE models provides a rationale for inflation targeting strategies, there is no model doing such a job for the strategy implemented for almost ten years now by the Eurosystem and known as the "two-pillar monetary policy strategy". We try to address this issue by developing a small "two-pillar" DSGE model for the euro area. In this paper: 1) we allow real balances to appear both in the IS and Phillips curves; 2) we find some evidence that money plays a non-trivial role in explaining the euro area business cycle; 3) this provides a rationale for the central bank (the European Central Bank) to factor in monetary developments, by exploiting the long-run relationship between money growth and inflation, eventually accounting for structural shifts in velocity; 4) we found some evidence that the ECB has reacted systematically to a filtered measure of money growth and weaker evidence it has reacted more aggressively during high money growth periods ("excess liquidity").
Keywords: Monetary policy, Monetary aggregates, Monetary Policy Rules, Non-linearity, ECB
JEL Classification: E52, E58
Suggested Citation: Suggested Citation