Monetary Policy in the Euro Area: Active or Passive?

Alice Albonico, Guido Ascari and Qazi Haque

No 535, Working Papers from University of Milano-Bicocca, Department of Economics

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 (search for similar items in EconPapers)
JEL-codes: C11 C13 E32 E52 (search for similar items in EconPapers)
Pages: 66
Date: 2024-05
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-eec, nep-mon and nep-opm
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Related works:
Working Paper: Monetary Policy in the Euro Area: Active or Passive? (2024)
Working Paper: Monetary Policy in the Euro Area: Active or Passive? (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:mib:wpaper:535

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