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Optimal Monetary Policy in an Estimated DSGE Model of the Euro Area with Cross-Country Heterogeneity

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  • Eric Jondeau

    (University of Lausanne and Swiss Finance Institute)

  • Jean-Guillaume Sahuc

    (Banque de France and Audencia School of Management)

Abstract

This paper investigates the implications of cross-country heterogeneity within the euro area for the design of optimal monetary policy. We build an optimization-based multicountry model (MCM) describing the euro area in which differences between structural parameters across countries are allowed. Using Bayesian techniques, we estimate the MCM and its areawide counterpart (AWM).We then question which model is the most appropriate for monetary policy purposes. Several results emerge. First, using an AWM induces relatively large and significant welfare losses. Second, this is not the use of a rule based on aggregated variables that is costly in terms of welfare, but rather the use of a suboptimal forecasting model. Third, allowing for habit on consumption has important implications for the dynamics of models, but taking into account differences in price indexation has more drastic effects on welfare losses.

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Bibliographic Info

Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 4 (2008)
Issue (Month): 2 (June)
Pages: 23-72

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Handle: RePEc:ijc:ijcjou:y:2008:q:2:a:2

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Cited by:
  1. Di Bartolomeo Giovanni & Tirelli Patrizio & Acocella Nicola, 2010. "Trend inflation, endogenous mark-ups and the non-vertical Phillips curve," wp.comunite 0065, Department of Communication, University of Teramo.
  2. Jondeau, Eric & Sahuc, Jean-Guillaume, 2008. "Testing heterogeneity within the euro area," Economics Letters, Elsevier, vol. 99(1), pages 192-196, April.
  3. Clerc, Laurent & Dellas, Harris & Loisel, Olivier, 2011. "To be or not to be in monetary union: A synthesis," Journal of International Economics, Elsevier, vol. 83(2), pages 154-167, March.
  4. Brissimis, Sophocles N. & Skotida, Ifigeneia, 2008. "Optimal monetary policy in the euro area in the presence of heterogeneity," Journal of International Money and Finance, Elsevier, vol. 27(2), pages 209-226, March.
  5. Pei-Tha Gan, 2014. "The Optimal Economic Uncertainty Index: A Grid Search Application," Computational Economics, Society for Computational Economics, vol. 43(2), pages 159-182, February.
  6. Lee, Jim, 2009. "Evaluating monetary policy of the euro area with cross-country heterogeneity: Evidence from a New Keynesian model," Economic Systems, Elsevier, vol. 33(4), pages 325-343, December.
  7. Sergei Ivashchenko, 2013. "Dynamic stochastic general equilibrium model with banks and endogenous defaults of firms," EUSP Deparment of Economics Working Paper Series Ec-02/13, European University at St. Petersburg, Department of Economics.
  8. Imbs, Jean & Jondeau, Eric & Pelgrin, Florian, 2011. "Sectoral Phillips curves and the aggregate Phillips curve," Journal of Monetary Economics, Elsevier, vol. 58(4), pages 328-344.
  9. Poilly, C. & Sahuc, J-G., 2008. "Welfare Implications of Heterogeneous Labor Markets in a Currency Area," Working papers 199, Banque de France.
  10. Dufour, Jean-Marie & Khalaf, Lynda & Kichian, Maral, 2010. "On the precision of Calvo parameter estimates in structural NKPC models," Journal of Economic Dynamics and Control, Elsevier, vol. 34(9), pages 1582-1595, September.
  11. Paolo Angelini & Paolo Del Giovane & Stefano Siviero & Daniele Terlizzese, 2008. "Monetary Policy in a Monetary Union: What Role for Regional Information?," International Journal of Central Banking, International Journal of Central Banking, vol. 4(3), pages 1-28, September.
  12. Hristov, Nikolay & Hülsewig, Oliver & Wollmershäuser, Timo, 2013. "Financial Frictions and Inflation Differentials in a Monetary Union," Munich Reprints in Economics 19365, University of Munich, Department of Economics.
  13. Di Bartolomeo, Giovanni & Tirelli, Patrizio & Acocella, Nicola, 2012. "Inflation targets and endogenous wage markups in a New Keynesian model," Journal of Macroeconomics, Elsevier, vol. 34(2), pages 391-403.
  14. Carla Soares, 2008. "Heterogeneity in a Monetary Union and its Impact on Welfare," Economic Bulletin and Financial Stability Report Articles, Banco de Portugal, Economics and Research Department.
  15. Di Bartolomeo Giovanni & Tirelli Patrizio & Acocella Nicola, 2011. "Trend inflation, the labor market wedge, and the non-vertical Phillips curve," wp.comunite 0081, Department of Communication, University of Teramo.
  16. Carla Soares, 2008. "Impact on Welfare of Country Heterogeneity in a Currency Union," Working Papers w200814, Banco de Portugal, Economics and Research Department.
  17. Moons, Cindy, 2009. "An Estimated Two-Country DSGE Model: losses from UK membership in EMU," Working Papers 2009/23, Hogeschool-Universiteit Brussel, Faculteit Economie en Management.

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