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Modeling the impact of external factors on the euro area’s HICP and real economy - a focus on pass-through and the trade balance

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Author Info
Luigi Landolfo () (Department of Economics, University of Warwick, Coventry, CV4 7AL, United Kingdom.)
Abstract

This paper aims to analyze the impact of external factors, such as the nominal effective exchange rate, foreign demand and the terms of trade, on the euro area real economy. In particular, the paper estimates the quantitative impact that changes in these factors have on net trade, real GDP and the Harmonized Consumer Price Index (HICP). To this end, we estimate a Dynamic Simultaneous Equation Model (DSEM) accounting for the presence of key exogenous variables. The tool utilized here to measure the impact of various shocks on the real economy is the impulse response function. The study is also conducted at sub-components level. First, we estimate the model replacing net trade with its sub-components, namely, the volume of exports and the volume of imports. Then, we re-estimate the model by dividing the terms of trade index into import and export prices. Overall, we estimate three models. Two of these models show consistent results. We found that the nominal effective exchange rate and foreign demand are the main determinants of the trade balance. Nevertheless, while foreign demand strongly affects real GDP, the nominal effective exchange rate affects it only slightly. Among the external factors, foreign demand has the strongest impact on real GDP. Regarding the impact of the nominal effective exchange rate on import prices and HICP, we found that the exchange rate pass-through for the euro area is not very high. This result is broadly in line with the findings presented in Hahn (2003). JEL Classification: C32, E52.

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Paper provided by European Central Bank in its series Working Paper Series with number 789.

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Length: 56 pages
Date of creation: Jul 2007
Date of revision:
Handle: RePEc:ecb:ecbwps:20070789

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Related research
Keywords: Net trade; Real economy; ECB.;

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References listed on IDEAS
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  1. Antonio Afonso & Peter Claeys, 2007. "The dynamic behaviour of budget components and output," Working Paper Series 775, European Central Bank. [Downloadable!]
    Other versions:
  2. Giovanni Lombardo & David Vestin, 2007. "Welfare implications of Calvo vs. Rotemberg pricing assumptions," Working Paper Series 770, European Central Bank. [Downloadable!]
    Other versions:
  3. Lawrence Christiano & Roberto Motto & Massimo Rostagno, 2007. "Shocks, Structures or Monetary Policies? The Euro Area and US After 2001," NBER Working Papers 13521, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Michael U. Krause & Thomas A. Lubik, 2007. "On-the-job search and the cyclical dynamics of the labor market," Working Paper Series 779, European Central Bank. [Downloadable!]
    Other versions:
  5. Michiel van Leuvensteijn & Jacob A. Bikker & Adrian A.R.J.M. van Rixtel & Christoffer Kok Sørensen, 2007. "A new approach to measuring competition in the loan markets of the euro area," Working Paper Series 768, European Central Bank. [Downloadable!]
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  6. Luca Benati & Haroon Mumtaz, 2007. "U.S. evolving macroeconomic dynamics - a structural investigation," Working Paper Series 746, European Central Bank. [Downloadable!]
  7. Elena Carletti & Philipp Hartmann & Steven Ongena, 2007. "The economic impact of merger control - what is special about banking?," Working Paper Series 786, European Central Bank. [Downloadable!]
  8. Ana Lamo & Javier J. Pérez & Ludger Schuknecht, 2007. "The cyclicality of consumption, wages and employment of the public sector in the euro area," Working Paper Series 757, European Central Bank. [Downloadable!]
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