Inflation Target Shocks and Monetary Policy Inertia in the Euro Area

Patrick Fève, J. Materon and Jean-Guillaume Sahuc ()

Documents de Travail from Banque de France

Abstract: The Euro area as a whole has experienced a marked downward trend in inflation over the past decades and, concomitantly, a protracted period of depressed activity. Can permanent and gradual shifts in monetary policy be held responsible for these dynamics? To answer this question, we embed serially correlated changes in the inflation target into a DSGE model with real and nominal frictions. The formal Bayesian estimation of the model suggests that gradual changes in the inflation target have played a major role in the Euro area business cycle. Following an inflation target shock, the real interest rate increases sharply and persistently, leading to a protracted decline in economic activity. Counter--factual exercises show that, had monetary policy implemented its new inflation objective at a faster rate, the Euro zone would have experienced more sustained growth than it actually did.

Keywords: Inflation target shocks; Gradualism; DSGE models; Bayesian econometrics. (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-eec, nep-mac and nep-mon
Date: 2009
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Related works:
Working Paper: Inflation Target Shocks and Monetary Policy Inertia in the Euro Area (2008)
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Persistent link: http://EconPapers.repec.org/RePEc:bfr:banfra:243

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