Monetary policy shocks and cross-country heterogeneity in the Euro area

Abstract

In our thesis, we analyze the transmission of monetary policy in the four largest Euro area economies, namely Germany, Italy, France and Spain. The focus of the analysis is to examine the heterogeneity and time variation in response to common monetary policy shocks for the period spanning from 2004:09-2016:12. For that purpose, we employ a data-rich environment along with a two-step factoraugmented vector autoregressive model (FAVAR), introduced by Bernanke, Boivin, and Eliasz in 2005. Moreover, in order to investigate the time-varying impacts of the policy effects and the impact of the financial and sovereign debt crisis on the transmission mechanism, we also use a rolling window technique. According to our empirical investigation using these methods, the thesis obtains the following main conclusions: Firstly, the contractionary impact of the monetary tightening is heterogeneous for a majority of our measures, i.e. money supply, deposit liabilities and loans, while for most, the responses appear to be negative. Moreover, the impulse responses of monetary aggregate M1, deposit liabilities for households and lending for house purchase to monetary policy shocks are more heterogeneous than that of other key indicators. Throughout our analysis, we also observe a persistent difference in terms of heterogeneity between the core and the periphery of the EA. Among the financial indices, Spanish and Italian are surprisingly the least affected by the monetary tightening, while overall for our observed measures the responses appear to be the most homogeneous. Secondly, although the effects of the policy shocks on our whole sample approach mostly appear to be heterogeneous, we note that over time the transmission mechanism displays important differences. Namely, our rolling window estimations imply that the influence of the policy shock on our variables is rather homogeneous across countries for the period spanning from 2004:09- 2014:07. At the same time, the last two rolling windows, or when moving into the crisis period, i.e. 2007:09–2015:07 and 2008:09–2016:07, evidently imply more heterogeneous impact of the shock. We believe that these findings are crucial in order to further investigate whether or not the Euro area monetary transmission process is uneven to such extent, that it could complicate the conduct of the single monetary policy.