Country Shocks, Monetary Policy Expectations and ECB Decisions. A Dynamic Non-Linear Approach

43 Pages Posted: 15 Sep 2015

See all articles by Maximo Camacho

Maximo Camacho

Autonomous University of Barcelona - Department of Economics; Universidad de Murcia - Departamento de Metodos Cuantitativos

Danilo Leiva León

Central Bank of Chile

Gabriel Perez-Quiros

Banco de España

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Date Written: September 15, 2015

Abstract

Previous studies have shown that the effectiveness of monetary policy largely depends on market expectations about future policy actions. This paper proposes an econometric framework to address the effect of the current state of the economy on monetary policy expectations. Specifically, we study the effect of contractionary (or expansionary) demand (or supply) shocks hitting the euro area countries on the expectations about the ECB’s monetary policy in two stages. In the first stage, we construct indices of real activity and inflation dynamics for each country, based on soft and hard indicators. In the second stage, we use those indices to provide assessments of the type of aggregate shock hitting each country and assess its effect on monetary policy expectations at different horizons. Our results indicate that expectations are responsive to aggregate contractionary shocks, but not to expansionary shocks. In particular, contractionary demand shocks have a negative effect on short-term monetary policy expectations, while contractionary supply shocks have a negative effect on medium and long-term expectations. Moreover, shocks to different economies do not have significantly different effects on expectations, although some cross-country differences arise.

Keywords: business cycles, inflation cycles, monetary policy

JEL Classification: E32, C22, E27

Suggested Citation

Camacho, Maximo and León, Danilo Leiva and Perez-Quiros, Gabriel, Country Shocks, Monetary Policy Expectations and ECB Decisions. A Dynamic Non-Linear Approach (September 15, 2015). Banco de Espana Working Paper No. 1523, Available at SSRN: https://ssrn.com/abstract=2660717 or http://dx.doi.org/10.2139/ssrn.2660717

Maximo Camacho (Contact Author)

Autonomous University of Barcelona - Department of Economics ( email )

Avda. Diagonal 690
Barcelona, 08034
Spain

Universidad de Murcia - Departamento de Metodos Cuantitativos ( email )

Campus de Espinardo
30100 Murcia
Spain
+34 968 367 982 (Phone)

Danilo Leiva León

Central Bank of Chile ( email )

Publicaciones
Huerfanos 1185
Santiago
Chile

Gabriel Perez-Quiros

Banco de España ( email )

Madrid 28014
Spain

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