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Macroeconomic adjustment and heterogeneity in the euro area

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Abstract

We revisit the subject of country-level macroeconomic adjustment in the euro area in theabsence of autonomous monetary and exchange rate policy. We discuss how the procyclical real interest rate mechanism and the competitiveness channel of adjustment interact with various aspects of cross-country heterogeneity. Long-term differentials in steady-state inflation (due to structural factors, such as Balassa-Samuelson effect) and natural interest rate do not rule out the existence of an equilibrium, as long as they are offset by additional price level differentials. GMM estimates of the parameters of our stylized New Keynesian model imply that the competitiveness channel is effectively at work in EMU 12 in the sense of real exchange rate influence on the output gap, but market flexibility necessary to triggershifts in REER remains below the standards in New Keynesian empirical literature. They also suggest that the risk of the real interest rate effect is additionally reduced by low output gap responsiveness to country-specific real interest rates and mainly results from intrinsic inflation persistence. Our model does not confirm the existence of a premium when foreign markets are more rigid in relative terms. Promoting market flexibility, combating intrinsic inflation persistence and anchoring inflation expectations remain the main challenges for policymakers.

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  • Andrzej Toroj, 2009. "Macroeconomic adjustment and heterogeneity in the euro area," NBP Working Papers 54, Narodowy Bank Polski.
    • Handle: RePEc:nbp:nbpmis:54
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    Cited by:

    1. Andrzej Toroj, 2011. "Competitiveness channel in Poland and Slovakia: a pre-EMU DSGE analysis," NBP Working Papers 86, Narodowy Bank Polski.
    2. Andrzej Torój, 2009. "Solving Forward-Looking Models of Cross-Country Adjustment within the Euro Area," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 1(3), pages 211-241, November.
    3. Arnold, Ivo J.M. & Soederhuizen, Beau, 2016. "Internal or external devaluation? What does the EC Consumer Survey tell us about macroeconomic adjustment in the Euro area?," Journal of International Money and Finance, Elsevier, vol. 64(C), pages 88-103.
    4. MENGUY, Séverine, 2023. "Stabilization of supply shocks in a structurally heterogeneous monetary union✰," Research in Economics, Elsevier, vol. 77(3), pages 362-389.

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    More about this item

    Keywords

    EMU; euro area heterogeneity; competitiveness channel; real interest rate effect; GMM; solution of RE models;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • F15 - International Economics - - Trade - - - Economic Integration
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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