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Inflation Target Shocks and Monetary Policy Inertia in the Euro Area

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Author Info
Fève,P.
Materon,J.
Sahuc, J-G.

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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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Publisher Info
Paper provided by Banque de France in its series Documents de Travail 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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Postal: Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS
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Related research
Keywords: Inflation target shocks ; Gradualism ; DSGE models ; Bayesian econometrics.;

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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