Dancing Alone or Together: The Dynamic Effects of Independent and Common Monetary Policies

Povilas Lastauskas and Julius Stakėnas

A chapter in Essays in Honor of M. Hashem Pesaran: Prediction and Macro Modeling, 2022, vol. 43A, pp 217-241 from Emerald Group Publishing Limited

Abstract: What would have been the hypothetical effect of monetary policy shocks had a country never joined the euro area, in cases where we know that the country in question actually did join the euro area? It is one thing to investigate the impact of joining a monetary union, but quite another to examine two things at once: joining the union and experiencing actual monetary policy shocks. The authors propose a methodology that combines synthetic control ideas with the impulse response functions to uncover dynamic response paths for treated and untreated units, controlling for common unobserved factors. Focusing on the largest euro area countries, Germany, France, and Italy, the authors find that an unexpected rise in interest rates depresses inflation and significantly appreciates exchange rate, whereas gross domestic product (GDP) fluctuations are less successfully controlled when a country belongs to the monetary union than would have been the case under the independent monetary policy. Importantly, Italy turns out to be the overall beneficiary, since all three channels – price, GDP, and exchange rate – deliver the desired results. The authors also find that stabilizing an economy within a union requires somewhat smaller policy changes than attempting to stabilize it individually, and therefore provides more policy space.

Keywords: Dynamic causal effects; monetary union; price puzzle; common factors; impulse response functions; counterfactuals; C14; C32; C33; E52 (search for similar items in EconPapers)
Date: 2022
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Working Paper: Dancing Alone or Together: The Dynamic Effects of Independent and Common Monetary Policies (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:eme:aecozz:s0731-90532021000043a011

DOI: 10.1108/S0731-90532021000043A011

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