Following Germany's Lead: Using International Monetary Linkages to Identify the Effect of Monetary Policy on the Economy

46 Pages Posted: 26 Feb 2005

See all articles by Julian di Giovanni

Julian di Giovanni

Federal Reserve Banks - Federal Reserve Bank of New York; Universitat Pompeu Fabra - Department of Economics and Business; Barcelona Graduate School of Economics (Barcelona GSE); CREI and Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR)

Justin McCrary

Columbia University - Law School; National Bureau of Economic Research (NBER)

Till von Wachter

Columbia Business School - Economics Department; IZA Institute of Labor Economics

Date Written: February 2005

Abstract

Forward-looking behavior on the part of the monetary authority leads least squares estimates to understate the true growth consequences of monetary policy interventions. We present instrumental variables estimates of the impact of interest rates on real output growth for several European countries, using German interest rates as the instrument. We compare this identification strategy to the vector autoregression approach, and give an interpretation of our estimates that is appropriate in a dynamic context. Moreover, we show that the difference between least squares and instrumental variables estimates provides bounds for the degree of endogeneity in monetary policy. The results confirm a considerable downward bias of estimates that do not account for potential forward-looking monetary policy decisions. The bias is higher for countries whose monetary policy was more independent of Germany.

Keywords: monetary policy, forward looking bias, instrumental variables

JEL Classification: E52, J60

Suggested Citation

di Giovanni, Julian and McCrary, Justin and von Wachter, Till, Following Germany's Lead: Using International Monetary Linkages to Identify the Effect of Monetary Policy on the Economy (February 2005). Available at SSRN: https://ssrn.com/abstract=673403

Julian Di Giovanni

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

HOME PAGE: http://julian.digiovanni.ca

Universitat Pompeu Fabra - Department of Economics and Business ( email )

Barcelona
Spain

HOME PAGE: http://julian.digiovanni.ca

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

HOME PAGE: http://julian.digiovanni.ca

CREI and Universitat Pompeu Fabra ( email )

HOME PAGE: http://julian.digiovanni.ca

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://julian.digiovanni.ca

Justin McCrary

Columbia University - Law School ( email )

435 West 116th Street
New York, NY 10025
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Till Von Wachter (Contact Author)

Columbia Business School - Economics Department ( email )

420 West 118th Street
New York, NY 10027
United States

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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