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Shocks, structures or monetary policies? The euro area and US after 2001

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  • Christiano, Lawrence
  • Motto, Roberto
  • Rostagno, Massimo

Abstract

The US Federal Reserve cut interest rates more vigorously in the recent recession than the European Central Bank did. By comparison with the Fed, the ECB followed a more measured course of action. We use an estimated dynamic general equilibrium model with financial frictions to show that comparisons based on such simple metrics as the variance of policy rates are misleading. We find that - because there is greater inertia in the ECB’s policy rule - the ECB’s policy actions actually had a greater stabilizing effect than did those of the Fed. As a consequence, a potentially severe recession turned out to be only a slowdown, and inflation never departed from levels consistent with the ECB’s quantitative definition of price stability. Other factors that account for the different economic outcomes in the Euro Area and US include differences in shocks and differences in the degree of wage and price flexibility. JEL Classification: C51, E52, E58

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0774.

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Date of creation: Jul 2007
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Handle: RePEc:ecb:ecbwps:20070774

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Keywords: DSGE model; Policy activism; policy inertia; shocks;

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  1. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  2. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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