Thesis Abstract

Abstract
This paper develops a small estimated model of the euro area economy that incorporates rational expectations and nominal rigidities. The model is estimated for the period 1999-2018 using Bayesian techniques, and it includes key features such as habit formation in consumption, adjustment costs in investment, and price and wage rigidities. We find that the estimated model is able to replicate the key macroeconomic dynamics of the euro area, including the effects of monetary policy shocks on output and inflation. Furthermore, the model is able to generate realistic responses to other types of shocks, such as technology and government spending shocks. Our results suggest that nominal rigidities play a key role in the transmission of monetary policy in the euro area, highlighting the importance of taking into account these frictions when analyzing the effects of policy interventions. Additionally, we find evidence that the euro area economy has become more resilient to shocks over time, with the responses of output and inflation becoming less volatile since the global financial crisis. Finally, we use the estimated model to analyze the effects of alternative monetary policy rules on key macroeconomic variables. We find that a rule that targets both inflation and output stabilization performs better than rules that focus solely on inflation stabilization, highlighting the importance of considering the real effects of monetary policy in addition to its effects on prices. Overall, our estimated model provides a useful tool for policymakers and researchers to analyze the macroeconomic dynamics of the euro area and evaluate the effects of different policy interventions.

Thesis Overview

The objective of this paper is to estimate a small model of the euro area to be used as a laboratory for evaluating the performance of alternative monetary policy strategies. We start with the relationship between output and inflation and investigate the fit of the nominal wage contracting model due to Taylor (1980) and three different versions of the relative real wage contracting model
proposed by Buiter and Jewitt (1981) and estimated by Fuhrer and Moore (1995a) for the United
States. While Fuhrer and Moore reject the nominal contracting model and find strong evidence in
favor of the relative contracting model which induces a higher degree of inflation persistence, we
find that both types of contracting models fit euro area data reasonably well. The best fitting
specification is a version of the relative contracting model, but one that is theoretically more
plausible than the one preferred by Fuhrer and Moore for U.S. data.
A drawback of the euro area estimation is that the data are averaged over the member economies,
which experienced different monetary policy regimes prior to the formation of EMU. Whereas
Germany enjoyed stable inflation with fairly predictable monetary policy, countries such as Italy and
France experienced a long-drawn out and probably imperfectly anticipated disinflation. To investigate the validity of our results, we also obtain estimates for France, Germany and Italy separately. We find that the relative contracting model does quite well in countries which transitioned out of a high inflation regime such as France and Italy, while the nominal contracting model fits German data better. Thus, an optimist may conclude that the independent European Central Bank will face a similar environment in the future as the Bundesbank did in Germany and pick the nominal contracting specification, while a pessimist, who suspects that stabilizing euro area inflation will require higher output losses, may want to pick the relative contracting specification. We close the model by estimating an aggregate demand relationship and investigate the consequences of the different wage contracting specifications for the output costs associated with stabilizing inflation, when interest rates are set according to Taylors rule.