Structural changes in the euro area - An evaluation of changes in the transmission mechanisms of monetary policy for selected economies

University essay from Handelshögskolan i Stockholm/Institutionen för nationalekonomi

Abstract: In the recent decades, there have been major developments in the euro area: increased globalization, changes in the financial markets and a restructuring of the euro area economy during the transition to economic and monetary union (EMU). This empirical study analyzes the impacts of these developments - with a special focus on the transition to EMU - on the transmission mechanisms of monetary policy for selected Member States of the euro area (Germany, France, the Netherlands, Italy, Spain and Portugal). According to the Lucas critique, major changes in policy regimes can influence the dynamics of econometric models. Therefore, a time-varying vector autoregressive (TV-VAR) model is employed to test for and identify structural changes. The empirical study provides strong evidence for parameter instabilities during the observation period between 1990m1 (1992m1 for Germany) and 2007m12 for all countries. The identified changes in the transmission mechanisms seem to occur rather instantaneously and mostly around the period between stage two and three of the transition to EMU. Evidence on the effects of structural changes on the transmission mechanisms is mixed for the analyzed variables and countries. However, the empirical study provides suggestive evidence for changes in the evolution of changes in the short-term interest rate after the occurrence of a shock that appear to have become more persistent. Furthermore, a certain degree of convergence of the effects of monetary policy shocks can be observed for countries of the same type.

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