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A Two-Pillar DSGE Monetary Policy Model for the Euro Area

  • Barthélemy, J.
  • Clerc L.
  • Marx, M.

Whereas the bulk of the literature on DSGE models provides a rationale for inflation targeting strategies, there is no model doing such a job for the strategy implemented for almost ten years now by the Eurosystem and known as the "two-pillar monetary policy strategy". We try to address this issue by developing a small "two-pillar" DSGE model for the euro area. In this paper: 1) we allow real balances to appear both in the IS and Phillips curves; 2) we find some evidence that money plays a non-trivial role in explaining the euro area business cycle; 3) this provides a rationale for the central bank (the European Central Bank) to factor in monetary developments, by exploiting the long-run relationship between money growth and inflation, eventually accounting for structural shifts in velocity; 4) we found some evidence that the ECB has reacted systematically to a filtered measure of money growth and weaker evidence it has reacted more aggressively during high money growth periods ("excess liquidity").

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Paper provided by Banque de France in its series Working papers with number 219.

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Length: 37 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:bfr:banfra:219
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