ONE BUT NOT THE SAME: ASSESSING THE HETEROGENEOUS EFFECTS OF MONETARY POLICY ACROSS THE EURO AREA USING STRUCTURAL VECTOR AUTOREGRESSIONS

Abstract

In the last decade, the European Central Bank (ECB) has reacted to the Global Financial Crisis and the Euro Crisis with an unprecedented level of monetary stimulus through unconventional monetary policies. This has sparked a debate about the effects of the ECB’s monetary policy across the Euro Area, both at the aggregate Euro Area level and at the country level. In this paper, I estimate different structural vector autoregressions (SVARs) to understand the effects of the ECB’s monetary policy both at the aggregate level and across countries. I adapt the identification through heteroskedasticity employed by Brunnermeier, Palia, Sastry and Sims (2019) for the US to the Euro Area. This method identifies the structural shocks given that their variance differs across time and does not require any strict short or long run restrictions on the coefficients of the SVAR. The results for the aggregate Euro Area SVAR are consistent with the previous literature, identifying a contractionary monetary policy shock as a contemporaneous rise in the shadow short rate, a significant decline in output and a less significant decline in the price level. I also find that the shadow short rate endogenously responds to other shocks, although less significantly. Next, I extend the Euro Area model by adding country variables to construct a SVAR for each country. The estimates show heterogeneous responses to a monetary policy shock across countries, with crisis countries responding more strongly in terms of output, sovereign financial stress, and to a lesser extent prices. When I group countries into two blocs in a single SVAR based on the spread of their sovereign bond yields with respect to Germany, the heterogeneous responses to a monetary policy shock disappear. These findings suggest that the ECB has developed a monetary policy toolkit that can maintain an aggregate homogenous response to its monetary policy while stimulating more strongly crisis countries. Thus, policymakers should continue efforts to ensure the “one, but not the same” nature of monetary policy across the Euro Area remains sustainable.