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

Povilas Lastauskas and Julius Stakenas ()
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Julius Stakenas: Vilnius University

No 87, Bank of Lithuania Working Paper Series from Bank of Lithuania

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. We 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, we find that an unexpected rise in interest rates depresses inflation and significantly appreciates exchange rate, whereas 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. We 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 (search for similar items in EconPapers)
JEL-codes: C14 C32 C33 E52 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2021-03-26
New Economics Papers: this item is included in nep-cba, nep-eec, nep-mac, nep-mon and nep-opm
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Chapter: Dancing Alone or Together: The Dynamic Effects of Independent and Common Monetary Policies (2022)
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