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A Small Forward-Looking Macroeconomic Model for EMU

Listed author(s):
  • Rafael Domenech
  • Mayte Ledo
  • David Taguas

In this paper we estimate a small forward-looking macroeconomic model for EMU which allows us to analyze the transmission mechanism of the monetary policy implemented by the European Central Bank through an interest rate rule that stabilizes inflation and output. The estimation of this model, which comprises forwardlooking versions of the IS and the Phillips curves as well as the interest rate rule, is conducted by GMM using quarterly data from 1986 to 2000. We find that this simple model matches the dynamic properties of the output gap, inflation and the interest rate in EMU quite accurately. We also perform several exercises that show the response of output, inflation and interest rates to different kinds of shocks affecting the economy, under the assumption that the ECB implements the monetary policy described by the estimated interest rate rule. Comparisons with backward-looking models for the United States show that our forward-looking model produces less persistence of the endogenous variables in response to shocks of the same magnitude.

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Paper provided by BBVA Bank, Economic Research Department in its series Working Papers with number 0102.

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Date of creation: Jul 2001
Handle: RePEc:bbv:wpaper:0102
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  1. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  2. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Working Papers in Applied Economic Theory 98-03, Federal Reserve Bank of San Francisco.
  3. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
  4. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
  5. Bennett T. McCallum, 2001. "Should Monetary Policy Respond Strongly to Output Gaps?," American Economic Review, American Economic Association, vol. 91(2), pages 258-262, May.
  6. Bennett T. McCallum & Edward Nelson, 1998. "Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model," NBER Working Papers 6599, National Bureau of Economic Research, Inc.
  7. Taylor, John B., 1998. "The Robustness and Efficiency of Monetary Policy Rules as Guidelines for Interest Rate Setting by the European Central Bank," Seminar Papers 649, Stockholm University, Institute for International Economic Studies.
  8. Bennett T McCallum & Edward Nelson, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimising Agents and Sticky Prices," Discussion Papers 05, Monetary Policy Committee Unit, Bank of England.
  9. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," Working Papers 97-32, C.V. Starr Center for Applied Economics, New York University.
  10. Gali, Jordi & Gertler, Mark & Lopez-Salido, J. David, 2001. "European inflation dynamics," European Economic Review, Elsevier, vol. 45(7), pages 1237-1270.
  11. Ehrmann, Michael & Smets, Frank, 2003. "Uncertain potential output: implications for monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 27(9), pages 1611-1638, July.
  12. Galí, Jordi & Gertler, Mark, 1999. "Inflation Dynamics: A Structural Economic Analysis," CEPR Discussion Papers 2246, C.E.P.R. Discussion Papers.
  13. Gerlach, Stefan & Smets, Frank, 1999. "Output gaps and monetary policy in the EMU area1," European Economic Review, Elsevier, vol. 43(4-6), pages 801-812, April.
  14. John P. Judd & Glenn D. Rudebusch, 1998. "Taylor's rule and the Fed, 1970-1997," Economic Review, Federal Reserve Bank of San Francisco, pages 3-16.
  15. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  16. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-1311, July.
  17. Gerlach, Stefan & Schnabel, Gert, 1999. "The Taylor Rule and Interest Rates in the EMU Area," CEPR Discussion Papers 2271, C.E.P.R. Discussion Papers.
  18. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  19. Kevin J. Lansing, 2002. "Learning about a shift in trend output: implications for monetary policy and inflation," Working Paper Series 2000-16, Federal Reserve Bank of San Francisco.
  20. Smets, Frank, 2000. "What horizon for price stability," Working Paper Series 0024, European Central Bank.
  21. Richard H. Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar, pages -.
  22. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
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