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Inflation Target Shocks and Monetary Policy Inertia in the Euro Area

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  • Fève,P.
  • Matheron,J.
  • Sahuc, J-G.

Abstract

The Euro area as a whole has experienced a marked downward trend in inflation over the past decades and, concomitantly, a protracted period of depressed activity. Can permanent and gradual shifts in monetary policy be held responsible for these dynamics? To answer this question, we embed serially correlated changes in the inflation target into a DSGE model with real and nominal frictions. The formal Bayesian estimation of the model suggests that gradual changes in the inflation target have played a major role in the Euro area business cycle. Following an inflation target shock, the real interest rate increases sharply and persistently, leading to a protracted decline in economic activity. Counter--factual exercises show that, had monetary policy implemented its new inflation objective at a faster rate, the Euro zone would have experienced more sustained growth than it actually did.

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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 243.

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Length: 30 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:bfr:banfra:243

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Keywords: Inflation target shocks ; Gradualism ; DSGE models ; Bayesian econometrics.;

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Cited by:
  1. Sacht, Stephen & Franke, Reiner & Jang, Tae-Seok, 2013. "Moment Matching versus Bayesian Estimation: Backward-Looking Behaviour in a New-Keynesian Baseline Model," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79694, Verein für Socialpolitik / German Economic Association.
  2. Benchimol, Jonathan & Fourçans, André, 2012. "Money and risk in a DSGE framework: A Bayesian application to the Eurozone," Journal of Macroeconomics, Elsevier, vol. 34(1), pages 95-111.
  3. Jonathan Benchimol & André Fourçans, 2012. "The role of money and monetary policy in crisis periods: the Euro area case," Post-Print hal-00672806, HAL.
  4. Franke, Reiner & Jang, Tae-Seok & Sacht, Stephen, 2011. "Moment matching versus Bayesian estimation: Backward-looking behaviour in the new-Keynesian three-equations model," Economics Working Papers 2011,10, Christian-Albrechts-University of Kiel, Department of Economics.

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