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The Exchange Rate and Monetary Conditions in the Euro Area

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  • Mayes, David G.

    ()
    (Bank of Finland Research)

  • Viren, Matti

    ()
    (Bank of Finland Research)

Abstract

Using information from a variety of sources, including our own estimates from quarterly data for each of the countries over the period 1972–1997, this paper suggests that the exchange rate will play an important role in the transmission of the impact of monetary policy through to the real economy and inflation in the euro area. Although the share of external trade in the euro area's GDP is only around 10 per cent this is only one factor that affects the transmission mechanism and the role of the exchange rate is likely to be substantially greater when all factors are taken into account. As a first approximation it would be reasonable to assume that an increase in the real 90-day interest rate of 100 basis points would have approximately the same effect on demand pressure two years later as a 3.5 per cent fall in the real euro exchange rate. This implies that the euro area will tend to behave like a large open economy rather than a closed economy and hence that it would be helpful in informing monetary policy to construct a Monetary Conditions Index (MCI) using these weights. A separate paper (Mayes and Virén, 1998) suggests how an MCI provides a useful summary of high frequency information to assist monetary policy and financial markets in short run decisions.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/DP_27_1998.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 27/1998.

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Length: 26 pages
Date of creation: 11 Dec 1998
Date of revision:
Handle: RePEc:hhs:bofrdp:1998_027

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Keywords: monetary conditions index; exchange rate; monetary policy; euro area;

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References

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Citations

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Cited by:
  1. Mayes, David G. & Viren, Matti, 2005. "Monetary policy problems for currency unions: asymmetry and the problem of aggregation in the euro area," Economic Modelling, Elsevier, vol. 22(2), pages 219-251, March.
  2. Muhamed Zulkhibri Abdul Majid, 2012. "Measuring monetary conditions in a small open economy: the case of Malaysia," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 4(3), pages 218-231, August.
  3. Fritz Breuss, 2002. "Was ECB's monetary policy optimal?," Atlantic Economic Journal, International Atlantic Economic Society, vol. 30(3), pages 298-319, September.
  4. Wladimir Andreff, 2001. "Les gains attendus par les pays d'Europe Centrale et Orientale de l'élargissement de l'Union européenne et de l'entrée dans l'euro," Revue d'Économie Financière, Programme National Persée, vol. 6(1), pages 49-64.
  5. Alberto Montagnoli & Oreste Napolitano, 2006. "Financial Condition Index and interest rate settings: a comparative analysis," Discussion Papers 2_2006, D.E.S. (Department of Economic Studies), University of Naples "Parthenope", Italy.
  6. Bofinger, Peter & Wollmershauser, Timo, 2001. "Is there a third way to EMU for the EU accession countries?," Economic Systems, Elsevier, vol. 25(3), pages 253-274, September.
  7. Alfred Guender, 2005. "On Optimal Monetary Policy Rules and the Construction of MCIs in the Open Economy," Open Economies Review, Springer, vol. 16(2), pages 189-207, April.
  8. Matti Virén, 1999. "Fiscal Policy, Automatic Stabilisers and Policy Coordination in EMU," Discussion Papers 204, Government Institute for Economic Research Finland (VATT).
  9. Mayes, David & Virén, Matti, 2009. "Changes in behaviour under EMU," Economic Modelling, Elsevier, vol. 26(4), pages 751-759, July.
  10. 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.
  11. David Mayes & Matti Viren, 2002. "Asymmetry and the Problem of Aggregation in the Euro Area," Empirica, Springer, vol. 29(1), pages 47-73, March.
  12. Wai Ching Poon, 2010. "Augmented MCi: AN Indicator Of Monetary Policy Stance For ASEAN-5?," Development Research Unit Working Paper Series 25-10, Monash University, Department of Economics.
  13. Wladimir Andreff, 2001. "The benefits of EU enlargement and Euro membership for Central and Eastern European Countries," Revue d'Économie Financière, Programme National Persée, vol. 6(1), pages 48-63.

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