Monetary Policy in the Euro Area: Active or Passive?

66 Pages Posted: 14 May 2024

See all articles by Alice Albonico

Alice Albonico

Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS); Università degli Studi di Milano-Bicocca - Center for European Studies (CefES)

Guido Ascari

University of Oxford; De Nederlandsche Bank; Centre for Economic Policy Research (CEPR)

Qazi Haque

University of Adelaide

Date Written: May 13, 2024

Abstract

We estimate a medium-scale DSGE model for the Euro Area allowing and testing for indeterminacy since the introduction of the euro until mid-2023.

Our estimates suggest that monetary policy in the euro area was passive, leading to indeterminacy and self-fulfilling dynamics. Indeterminacy dramatically alters the transmission of fundamental shocks, particularly for inflation whose responses are inconsistent with standard economic theory. Inflation increases following a positive supply or a negative demand shock. Consequently, demand shocks look like supply shocks and vice versa, making the dynamics of the model under indeterminacy challenging to interpret. However, this finding is not robust across different assumptions on the way the sunspot shock is specified in the estimation. Both under determinacy and indeterminacy, the model estimates a natural rate of interest that turned positive after the recent inflation episode.

Keywords: monetary policy, indeterminacy, euro area, business cycle fluctuations, inflation

JEL Classification: E32, E52, C11, C13

Suggested Citation

Albonico, Alice and Ascari, Guido and Haque, Qazi, Monetary Policy in the Euro Area: Active or Passive? (May 13, 2024). University of Milan Bicocca Department of Economics, Management and Statistics Working Paper No. 535, Available at SSRN: https://ssrn.com/abstract=4825603 or http://dx.doi.org/10.2139/ssrn.4825603

Alice Albonico (Contact Author)

Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS) ( email )

Piazza dell'Ateneo Nuovo, 1
Milano, 20126
Italy

Università degli Studi di Milano-Bicocca - Center for European Studies (CefES)

U6 Building
Viale Piero e Alberto Pirelli, 22
Milano, 20126
Italy

Guido Ascari

University of Oxford ( email )

De Nederlandsche Bank ( email )

Netherlands

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Qazi Haque

University of Adelaide ( email )

School of Economics, Faculty of the Professions
Nexux 10, 10 Pulteney Street
Adelaide, South Australia 5005
Australia

HOME PAGE: http://https://sites.google.com/site/qazigmziaulhaque/

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