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Monetary Policy Shocks in Open Economies and the Inflation Unemployment Trade-Off: The Case of the Euro Area

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  • Antonio Ribba

    (Antonio Ribba, Department of Economics Marco Biagi, University of Modena and Reggio Emilia, Viale Berengario 51, 41121 Modena, Italy)

Abstract

In this paper, we show that in order to obtain a sound identification of Euro Area monetary policy shocks, one needs to deal with the interaction of the European Central Bank and the US Federal Reserve. In other words, a proper identification of monetary policy shocks for an open economy like the Euro Area requires consideration of the US policy rate. Indeed, when we exclude the Federal Funds Rate from an estimated VAR model including a set of Euro Area variables, i.e., Eonia, inflation and unemployment, we detect a wrong sign in the response of inflation to contractionary monetary policy shocks. Moreover, even adding the world price of oil does not help to overcome the problem. Instead, for a sample covering the period 1999–2019, when the Federal Funds Rate and the Euro–Dollar exchange rate are added to the VAR model inflation shows statistically non-significant effects for two years and thereafter decreases. Under this specification of the model, a clear and significant unemployment inflation trade-off emerges. These conclusions are confirmed by using industrial production instead of the unemployment rate in the VAR model.

Suggested Citation

  • Antonio Ribba, 2022. "Monetary Policy Shocks in Open Economies and the Inflation Unemployment Trade-Off: The Case of the Euro Area," JRFM, MDPI, vol. 15(4), pages 1-12, March.
  • Handle: RePEc:gam:jjrfmx:v:15:y:2022:i:4:p:146-:d:777285
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    References listed on IDEAS

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