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Optimal Monetary Policy in the Euro Area in the Presence of Heterogeneity

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  • Sophocles N. Brissimis

    (Bank of Greece and University of Piraeus)

  • Ifigeneia Skotida

    ()
    (Bank of Greece and Athens University of Economics and Business)

Abstract

This paper examines the optimal design of monetary policy in the European monetary union in the presence of structural asymmetries across union member countries. It derives analytically an optimal interest rate rule under commitment and studies the dependence of its coefficients on the parameters of the structural model of each economy, the central bank's preferences for inflation and output stabilization as shown in its loss function, and the relative size of each country. Based on a twocountry, forward-looking, general equilibrium model, which is estimated for two euro area countries (Germany and France), we show that there are gains to be achieved by the ECB taking into account the heterogeneity of economic structures. This finding appears to be robust under alternative weights given by the central bank to the stabilization of the target variables. Although the implementation of the proposed rule involves difficulties relating to data and estimation constraints as well as risks of accommodating structural divergences, it is important that the ECB takes into consideration national characteristics in formulating its monetary policy, especially in view of more countries joining the European monetary union in the future. However, as monetary and financial integration advances, the welfare benefits of monetary policy responding to individual countries' variables may become less significant.

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Bibliographic Info

Paper provided by Bank of Greece in its series Working Papers with number 62.

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Length: 32 pages
Date of creation: Nov 2007
Date of revision:
Handle: RePEc:bog:wpaper:62

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Keywords: Monetary policy rules; Heterogeneous monetary union;

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Citations

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Cited by:
  1. Michael G. Arghyrou & Maria Dolores Gadea, 2008. "The single monetary policy and domestic macro-fundamentals: Evidence from Spain," Documentos de Trabajo dt2008-05, Facultad de Ciencias Económicas y Empresariales, Universidad de Zaragoza.
  2. Andrzej Torój, 2010. "Rationality of Expectations: Another OCA Criterion? A DSGE Analysis," Central European Journal of Economic Modelling and Econometrics, CEJEME, vol. 2(3), pages 205-252, June.
  3. Andrzej Toroj, 2011. "Competitiveness channel in Poland and Slovakia: a pre-EMU DSGE analysis," National Bank of Poland Working Papers 86, National Bank of Poland, Economic Institute.
  4. Stephan Barisitz, 2008. "Banking Transformation (1989 - 2006) in Central and Eastern Europe - With Special Reference to Balkans," Working Papers 78, Bank of Greece.
  5. 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.
  6. Milan Sojic & Ljiljana Djurdjevic, 2008. "Monetary Policy Objectives and Istruments used by the Privileged National Bank of the Kingdom of Serbia (1884 - 1914)," Working Papers 87, Bank of Greece.
  7. Torój, Andrzej, 2009. "Solving forward-looking models of cross-country adjustment within the euro area," MF Working Papers 1, Ministry of Finance in Poland.
  8. Roumen Avramov & Dragana Gnjatovic, 2008. "Stabilization Policies in Bulgaria and Yugoslavia During Communism's Terminal Years : 1980s Economic Visions in Retrospect," Working Papers 81, Bank of Greece.
  9. Jean-Sébastien Pentecôte, 2011. "Long-run identifying restrictions on VARs within the AS-AD framework," Economics Working Paper Archive (University of Rennes 1 & University of Caen) 201125, Center for Research in Economics and Management (CREM), University of Rennes 1, University of Caen and CNRS.
  10. Rob Ackrill and Simeon Coleman, 2012. "Inflation dynamics in central and eastern European countries," Working Papers 2012/01, Nottingham Trent University, Nottingham Business School, Economics Division.
  11. Apostolides, Alexander, 2008. "“How Similar to South-Eastern Europe were the Islands of Cyprus and Malta in terms of Agricultural Output and Credit? Evidence during the Interwar Period”," MPRA Paper 9968, University Library of Munich, Germany.
  12. Alagidede, Paul & Coleman, Simeon & Cuestas, Juan Carlos, 2012. "Inflationary shocks and common economic trends: Implications for West African monetary union membership," Journal of Policy Modeling, Elsevier, vol. 34(3), pages 460-475.
  13. Peter Bernholz, 2008. "Government Bankruptcy of Balkan Nations and their Consequences for Money and Inflation before 1914: A Comparative Analysis," Working Papers 74, Bank of Greece.
  14. Sophia Lazaretou, 2008. "Banking and Central Banking in Pre-WWII Grecce: Money and Currency Developments," Working Papers 86, Bank of Greece.
  15. 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.
  16. Zarko Lazarevic, 2008. "Banking Performance in South-Eastern Europe During the Interwar Period," Working Papers 79, Bank of Greece.
  17. Yuksel Gormez, 2008. "Banking in Turkey: History and Evolution," Working Papers 83, Bank of Greece.

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