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The Transmission of US Monetary Policy to the Euro Area

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  • Stefano Neri
  • Andrea Nobili

Abstract

This paper studies how changes in the federal funds rate by the US Federal Reserve affect the eurozone economy. In our analysis, the international transmission mechanism works through movements in the exchange rate, commodity prices, short-term interest rates and the trade balance. We find that an increase in the federal funds rate causes the euro to immediately depreciate, while commodity, and in particular oil, prices decline sharply, reflecting a decline in demand. Lower commodity prices stimulate household consumption in the short run, and the higher aggregate demand induces an expansion of eurozone economic activity. Our results show that the effects of changes in the federal funds rate on commodity prices are greater than previously found in the literature. Our analysis also assesses the likely effects on the eurozone economy of the European Central Bank's (ECB's) own responses to macroeconomic developments. We find that the expansionary effect of lower commodity prices and a depreciated euro on the eurozone economy is partially offset by the ECB increasing short-term nominal interest rates to curb inflationary pressures in an expanding economy. This result highlights the importance of commodity prices and the euro-dollar exchange rate as inputs into European monetary policy-making, as seen, for example, in the Eurosystem staff macroeconomic projections used by the Governing Council to assess the risks to price stability. Copyright 2010 Blackwell Publishing Ltd

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Bibliographic Info

Article provided by Wiley Blackwell in its journal International Finance.

Volume (Year): 13 (2010)
Issue (Month): 1 (03)
Pages: 55-78

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Handle: RePEc:bla:intfin:v:13:y:2010:i:1:p:55-78

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=1367-0271

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Cited by:
  1. Martin Mandler, 2010. "Explaining ECB and FED interest rate correlation: Economic interdependence and optimal monetary policy," MAGKS Papers on Economics 201025, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  2. Kazi, Irfan Akbar & Wagan, Hakimzadi & Akbar, Farhan, 2013. "The changing international transmission of U.S. monetary policy shocks: Is there evidence of contagion effect on OECD countries," Economic Modelling, Elsevier, vol. 30(C), pages 90-116.
  3. Eickmeier, Sandra & Lemke, Wolfgang & Marcellino, Massimiliano, 2011. "The changing international transmission of financial shocks: evidence from a classical time-varying FAVAR," Discussion Paper Series 1: Economic Studies 2011,05, Deutsche Bundesbank, Research Centre.

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