Heterogeneity in Euro Area Monetary Policy Transmission: Results from a large Multi-Country BVAR

We analyse empirically whether the common monetary policy of the Eurosystem has heterogeneous effects on the four large member countries of the European Monetary Union (France, Germany, Italy and Spain) focussing on possible cross-country differences in the reaction of output, the price level and financial variables to changes in the Euroystem’s monetary policy interest rate. We use a large multi-country Bayesian vector autoregression to jointly model the dynamics of output, prices and financial variables in the four countries after 1999. Following Giannone, Lenza, and Primiceri (2015) the prior distributions are selected in a data-driven way. We compare across countries the reactions of the variables to exogenous changes in the Eurosystem’s common monetary policy interest rate. The Bayesian approach specifically allows us to make explicit probabilistic statements about the extent of cross-country heterogeneity in the effects of monetary policy. We further strengthen the robustness our results using a battery of additional tests on cross-country differences in the distributions of the effects of monetary policy. Comparing the macroeconomic effects of an exogenous increase in the Eurosystem’s monetary policy interest rate across countries we find real output to respond less negatively in Spain compared to the other three countries while the drop in the price level is less pronounced in Germany relative to France, Italy and Spain. Bond yields rise more strongly and persistently in France and Germany compared to Italy and Spain.