Economic growth in the era of unconventional monetary instruments: A FAVAR approach

After the global financial crisis, the ECB, as other major central banks, has introduced new monetary instruments to effectively respond to economic and financial shocks. This paper aims to analyse the role of monetary policy in the Eurozone's economic activity and studies responses of industrial production and inflation to standard and non-standard monetary tools. First, we perform a VAR model to estimate the effects of exogenous innovations in conventional and unconventional tools on industrial production and inflation. Then, to summarize the external economic developments, we condense the information contained in a large set of time series into a few factors, and then put these factors in a new VAR model (FAVAR). The results show that the unconventional policy has played an important role on economic and financial stabilization. The empirical model suggests also how the contemporaneous implementation of the two different policies is “big guns” on hand to ECB.