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

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  • Jondeau, E.
  • Sahuc, J-G.

Abstract

This paper investigates the implications of cross-country heterogeneity within the euro area for the design of optimal monetary policy. We build an optimizing-based multi-country 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 area-wide 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 sub-optimal forecasting model. Third, allowing for habit on consumption has important implications for the dynamics of models but taking into account difference in price indexation has more drastic effects on welfare losses.

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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 141.

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Length: 45 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:bfr:banfra:141

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Postal: Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS
Web page: http://www.banque-france.fr/
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Keywords: Euro area ; Heterogeneity ; Optimal monetary policy ; Bayesian econometrics.;

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References

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Citations

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Cited by:
  1. Poilly, C. & Sahuc, J-G., 2008. "Welfare Implications of Heterogeneous Labor Markets in a Currency Area," Working papers 199, Banque de France.
  2. Ivashchenko, S., 2013. "Dynamic Stochastic General Equilibrium Model with Banks and Endogenous Defaults of Firms," Journal of the New Economic Association, New Economic Association, vol. 19(3), pages 27-50.
  3. 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.
  4. Giovanni Di Bartolomeo & Patrizio Tirelli & Nicola Acocella, 2010. "Trend inflation, endogenous mark-ups and the non-vertical Phillips curve," Working Papers 186, University of Milano-Bicocca, Department of Economics, revised May 2010.
  5. Di Bartolomeo Giovanni & Tirelli Patrizio & Acocella Nicola, 2011. "Inflation targets and endogenous wage markups in a New Keynesian model," wp.comunite 0079, Department of Communication, University of Teramo.
  6. Carla Soares, 2008. "Impact on Welfare of Country Heterogeneity in a Currency Union," Working Papers w200814, Banco de Portugal, Economics and Research Department.
  7. 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.
  8. Jondeau, Eric & Sahuc, Jean-Guillaume, 2008. "Testing heterogeneity within the euro area," Economics Letters, Elsevier, vol. 99(1), pages 192-196, April.
  9. 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.
  10. 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.
  11. 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.
  12. 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.
  13. Clerc, L. & Dellas, H. & Loisel, O., 2010. "To be or not to be in monetary union: A synthesis," Working papers 308, Banque de France.
  14. 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.
  15. 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.
  16. 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.
  17. 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.

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