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Macroeconomic Volatility Trade-off and Monetary Policy Regime in the Euro Area

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  • Alvaro Aguiar

    ()
    (CEMPRE, Faculdade de Economia da Universidade do Porto)

  • Manuel M. F. Martins

    ()
    (CEMPRE, Faculdade de Economia da Universidade do Porto)

Abstract

This research uncovers a well-defined monetary policy regime starting in 1986 in the aggregate Euro Area. Both alternative solution-estimation methods employed - optimal control cum GMM, and dynamic programming cum FIML - identify a regime of strict inflation targeting with interest rate smoothing. The unemployment gap, properly estimated as quasi real-time information, is a relevant element in the information set of the monetary authority, despite not being included in its preferences. The emergence of the regime relates to the improvement of the volatility trade-off between inflation and unemployment gap since the mid-80s. Additional improving factors have been milder supply shocks and better ability of policymakers to set the interest rate closer to optimum.

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Bibliographic Info

Paper provided by Universidade do Porto, Faculdade de Economia do Porto in its series FEP Working Papers with number 123.

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Length: 47 pages
Date of creation: Mar 2003
Date of revision:
Handle: RePEc:por:fepwps:123

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Keywords: Monetary Policy Regime; Euro Area; Optimal Control; Dynamic Programming; GMM; FIML.;

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  1. Mojon, Benoît & Kashyap, Anil K. & Angeloni, Ignazio & Terlizzese, Daniele, 2002. "Monetary Transmission in the Euro Area : Where Do We Stand?," Working Paper Series 0114, European Central Bank.
  2. Donald W.K. Andrews, 1988. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Cowles Foundation Discussion Papers 877R, Cowles Foundation for Research in Economics, Yale University, revised Jul 1989.
  3. Aksoy, Yunus & De Grauwe, Paul & Dewachter, Hans, 2002. "Do asymmetries matter for European monetary policy?," European Economic Review, Elsevier, vol. 46(3), pages 443-469, March.
  4. Agresti, Anna Maria & Mojon, Benoît, 2001. "Some stylised facts on the euro area business cycle," Working Paper Series 0095, European Central Bank.
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