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

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Author Info
Eric Jondeau (University of Lausanne and Swiss Finance Institute)
Jean-Guillaume Sahuc (Banque de France and Audencia School of Management)

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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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Publisher 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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Find related papers by JEL classification:
C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

References listed on IDEAS
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Full references

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.)

  1. Poilly, C. & Sahuc, J-G., 2008. "Welfare Implications of Heterogeneous Labor Markets in a Currency Area," Documents de Travail 199, Banque de France. [Downloadable!]
  2. Sophocles N. Brissimis & Ifigeneia Skotida, 2007. "Optimal Monetary Policy in the Euro Area in the Presence of Heterogeneity," Working Papers 62, Bank of Greece. [Downloadable!]
    Other versions:
  3. Jondeau, E. & Sahuc, J-G., 2007. "Testing heterogeneity within the euro area," Documents de Travail 181, Banque de France. [Downloadable!]
    Other versions:
  4. 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. [Downloadable!]
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