The monetary transmission mechanism in the Euro Area : has it changed with the EMU?

Abstract

We study whether the adoption of the euro and a single monetary policy have brought about a change in the monetary transmission mechanism and in the interactions of monetary policy, fiscal policy and financial stress in the euro area. We find that the stylized facts of monetary transmission remain valid but the response of output and, mainly, the fiscal and financial stress variables to a monetary policy shock seem to be stronger in the post-EMU period. These changes may signal a higher degree of synchronization of the euro area countries’ economies after the adoption of the euro. Regarding fiscal and financial stress shocks, the inclusion in the post-EMU period of the subprime and sovereign debt crises yields changes not only in the scale but also in the patterns of the responses of our model’s main variables. Overall, we conclude that the subprime and sovereign debt crises have contributed markedly to the post-EMU impulse response functions and, if those periods of financial turbulence are excluded, the responses of the macro variables to monetary, fiscal and financial stress shocks in the post-EMU period are of a remarkably small magnitude.