One Policy Rate, Many Stances: Evidence from the European Monetary Union

Manuel González-Astudillo and Diego Vilán
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Diego Vilán: https://www.federalreserve.gov/econres/diego-vilan.htm
Authors registered in the RePEc Author Service: Diego Vilán

No 2025-087, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: A challenge for conducting monetary policy in a currency union is the diverse economic conditions among member states. Such disparities can drive natural interest rates apart, thereby undermining the stabilizing role of a unified monetary policy. To assess the stance of monetary policy across Eurozone-19 countries, we estimate their natural rates of interest (r∗) and inflation trends (π∗) to construct a measure of the country-level neutral nominal interest rates (r∗ + π∗) over 1999-2025, using a semistructural model that jointly characterizes the trend and cyclical components of key macroeconomic variables such as output, unemployment, inflation, 10-year government bond yields, and the common policy interest rate. Our setup improves upon those in the existing literature by allowing both a short-run interest rate gap—driven by the (shadow) policy rate—and a long-run interest rate gap—driven by the country-specific 10-year government bond yields—to affect and reflect economic conditions. We also impose cointegration between the dynamics of the country-specific latent variables and common counterparts to incorporate co-movements across the euro area economies. Our results show that the stance of monetary policy is homogeneous across the countries in our sample, but that a relatively highly degree of heterogeneity emerges at key historical turning points.

Keywords: Common monetary policy challenges; Euro area economies; Interest rate gap; Neutral interest rate; Sovereign debt risk (search for similar items in EconPapers)
JEL-codes: C32 E32 E42 E52 (search for similar items in EconPapers)
Pages: 50 p.
Date: 2025-09-19
New Economics Papers: this item is included in nep-eec and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2025-87

DOI: 10.17016/FEDS.2025.087

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