Should the Euro Area be Run as a Closed Economy?

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Should the Euro Area be Run as a Closed Economy?

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Carlo Favero
Francesco Giavazzi

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Abstract

This paper studies monetary policy in the Euro area looking at the variable most directly related to current and expected monetary policy, the yield on long term government bonds. We find that the level of longterm rates in Europe is almost entirely explained by U.S. shocks and by the systematic response of U.S. and European variables (inflation, short term rates and the output gap) to these shocks. Our results suggest in particular that U.S. variables are more important than local variables in the policy rule followed by European monetary authorities: this was true for the Bundesbank before EMU and has remained true for the ECB, at least so far. Using closed economy models to analyze monetary policy in the Euro is thus inconsistent with the empirical evidence on the determinants of Euro area long-term rates. It is also inconsistent with the way the Governing Council of the ECB appears to make actual policy decisions.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 331.

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Date of creation: 2008
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Handle: RePEc:igi:igierp:331

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Article
- Carlo Favero & Francesco Giavazzi, 2008. "Should the Euro Area Be Run as a Closed Economy?," American Economic Review, American Economic Association, vol. 98(2), pages 138-45, May. [Downloadable!]
Paper
- Favero, Carlo A & Giavazzi, Francesco, 2008. "Should the Euro Area be Run as a Closed Economy?," CEPR Discussion Papers 6654, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

Roush, Jennifer E., 2007. "The expectations theory works for monetary policy shocks," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1631-1643, September. [Downloadable!] (restricted)
Evans, Charles L. & Marshall, David A., 1998. "Monetary policy and the term structure of nominal interest rates: Evidence and theory," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 53-111, December. [Downloadable!] (restricted)
Other versions:
- Charles L. Evans & David A. Marshall, 1997. "Monetary policy and the term structure of nominal interest rates: evidence and theory," Working Paper Series, Macroeconomic Issues WP-97-10, Federal Reserve Bank of Chicago.
Stéphane Dées & Isabel Vansteenkiste, 2007. "The transmission of US cyclical developments to the rest of the world," Working Paper Series 798, European Central Bank. [Downloadable!]
Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
Other versions:
- Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1997. "Monetary policy shocks: what have we learned and to what end?," Working Paper Series, Macroeconomic Issues WP-97-18, Federal Reserve Bank of Chicago.
- Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier. [Downloadable!] (restricted)
Wendy Edelberg & David Marshall, 1996. "Monetary policy shocks and long-term interest rates," Economic Perspectives, Federal Reserve Bank of Chicago, issue Mar, pages 2-17. [Downloadable!]

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Helge Berger & Thomas Harjes, 2009. "Does Global Liquidity Matter for Monetary Policy in the Euro Area?," IMF Working Papers 09/17, International Monetary Fund. [Downloadable!]

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