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Macroeconomic adjustment and heterogeneity in the euro area

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Author Info
Andrzej Toroj (Warsaw School of Economics)
Abstract

We revisit the subject of country-level macroeconomic adjustment in the euro area in theabsence of autonomous monetary and exchange rate policy. We discuss how the procyclical real interest rate mechanism and the competitiveness channel of adjustment interact with various aspects of cross-country heterogeneity. Long-term differentials in steady-state inflation (due to structural factors, such as Balassa-Samuelson effect) and natural interest rate do not rule out the existence of an equilibrium, as long as they are offset by additional price level differentials. GMM estimates of the parameters of our stylized New Keynesian model imply that the competitiveness channel is effectively at work in EMU 12 in the sense of real exchange rate influence on the output gap, but market flexibility necessary to triggershifts in REER remains below the standards in New Keynesian empirical literature. They also suggest that the risk of the real interest rate effect is additionally reduced by low output gap responsiveness to country-specific real interest rates and mainly results from intrinsic inflation persistence. Our model does not confirm the existence of a premium when foreign markets are more rigid in relative terms. Promoting market flexibility, combating intrinsic inflation persistence and anchoring inflation expectations remain the main challenges for policymakers.

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Paper provided by National Bank of Poland, Economic Institute in its series National Bank of Poland Working Papers with number 54.

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Length: 43
Date of creation: Jan 2009
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Handle: RePEc:nbp:nbpmis:54

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Related research
Keywords: EMU; euro area heterogeneity; competitiveness channel; real interest rate effect; GMM; solution of RE models;

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Find related papers by JEL classification:
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
F15 - International Economics - - Trade - - - Economic Integration
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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  1. Peter Hoeller & Claude Giorno & Christine de la Maisonneuve, 2002. "Overheating in Small Euro Area Economies: Should Fiscal Policy React?," OECD Economics Department Working Papers 323, OECD, Economics Department. [Downloadable!]
  2. Luis Cat�o & G. A. Mackenzie, 2006. "Perspectives on Low Global Interest Rates," IMF Working Papers 06/76, International Monetary Fund. [Downloadable!]
  3. Ivo J.M. Arnold & Jan J.G. Lemmen, 2008. "Inflation Expectations and Inflation Uncertainty in the Eurozone: Evidence from Survey Data," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 144(2), pages 325-346, July. [Downloadable!] (restricted)
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  4. Volker Clausen & Bernd Hayo, 2006. "Asymmetric monetary policy effects in EMU," Applied Economics, Taylor and Francis Journals, vol. 38(10), pages 1123-1134, June. [Downloadable!] (restricted)
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  5. Kalemli-Ozcan, Sebnem & Sorensen, Bent E & Yosha, Oved, 2004. "Asymmetric Shocks and Risk Sharing in a Monetary Union: Updated Evidence and Policy Implications for Europe," CEPR Discussion Papers 4463, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  6. Peter Hoeller & Claude Giorno & Christine de la Maisonneuve, 2004. "One Money, One Cycle?: Making Monetary Union a Smoother Ride," OECD Economics Department Working Papers 401, OECD, Economics Department. [Downloadable!]
  7. Stephan Sauer & Jan-Egbert Sturm, 2003. "Using Taylor Rules to Understand ECB Monetary Policy," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  8. António Afonso & Davide Furceri, 2007. "Business cycle synchronization and insurance mechanisms in the EU," Working Paper Series 844, European Central Bank. [Downloadable!]
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  9. Peter Hoeller & David Rae, 2007. "Housing Markets and Adjustment in Monetary Union," OECD Economics Department Working Papers 550, OECD, Economics Department. [Downloadable!]
  10. Philip R. Lane, 2006. "The Real Effects of EMU," The Institute for International Integration Studies Discussion Paper Series iiisdp115, IIIS. [Downloadable!]
    Other versions:
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