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

Julian di Giovanni, Justin McCrary () and Till von Wachter ()
Additional contact information
Justin McCrary: University of California, Berkeley
Till von Wachter: University of California, Los Angeles

No 1495, IZA Discussion Papers from Institute of Labor Economics (IZA)

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: forward looking bias; instrumental variables; monetary policy (search for similar items in EconPapers)
JEL-codes: E52 J60 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2005-02
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Published - published in: Review of Economics and Statistics, 2009, 91 (2), 315 - 331

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