Optimal Monetary Policy in an Estimated Dsge Model of the Euro Area with Cross-Country Heterogeneity

47 Pages Posted: 15 Mar 2005

See all articles by Eric Jondeau

Eric Jondeau

University of Lausanne - Faculty of Business and Economics (HEC Lausanne); Swiss Finance Institute

Jean-Guillaume Sahuc

Banque de France; Université Paris Ouest - Nanterre, La Défense - EconomiX

Multiple version iconThere are 2 versions of this paper

Date Written: November 2007

Abstract

This paper investigates the implications of cross-country heterogeneity within the euro area for the design of optimal monetary policy. We build an optimizing-based multi-country model (MCM) describing the euro area in which di¤erences between structural parameters across countries are allowed. Using Bayesian techniques, we estimate the MCM and its area-wide counterpart (AWM). We then question which model is the most appropriate for monetary policy purposes. Several results emerge. First, using an AWM induces relatively large and significant welfare losses. Second, this is not the use of a rule based on aggregated variables that is costly in terms of welfare, but rather the use of a sub-optimal forecasting model. Third, allowing for habit on consumption has important implications for the dynamics of models but taking into account di¤erence in price indexation has more drastic e¤ects on welfare losses.

Keywords: Euro area, heterogeneity, optimal monetary policy, Bayesian econometrics

JEL Classification: C51, E52, F41

Suggested Citation

Jondeau, Eric and Sahuc, Jean-Guillaume, Optimal Monetary Policy in an Estimated Dsge Model of the Euro Area with Cross-Country Heterogeneity (November 2007). Swiss Finance Institute Research Paper No. 07-36. Available at SSRN: https://ssrn.com/abstract=598022 or http://dx.doi.org/10.2139/ssrn.598022

Eric Jondeau (Contact Author)

University of Lausanne - Faculty of Business and Economics (HEC Lausanne) ( email )

Extranef 232
Lausanne, 1012
Switzerland
+41 21 692 33 49 (Phone)

HOME PAGE: http://www.hec.unil.ch/ejondeau/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Jean-Guillaume Sahuc

Banque de France ( email )

31 rue Croix des Petits Champs
75049 Paris Cedex 01
France
+33 1 42 92-49-52 (Phone)
+33 1 42-92-62-92 (Fax)

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

Université Paris Ouest - Nanterre, La Défense - EconomiX ( email )

200 Avenue de la République
Nanterre cedex, Nanterre Cedex 92000
France

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