The economic consequences of euro-area macro-modelling shortcuts

Abstract

Should euro-area economies be modelled in an aggregate (area-wide) fashion or in a disaggregate (multi-country) one? This article tackles that question from both statistical and economic viewpoint. From a statistical viewpoint, aggregation bias criteria are found to signal that the degree of structural heterogeneity among euro-area economies is such that the loss of information entailed by an aggregate modelling approach may be far from trifling. From an economic viewpoint, we investigate the following issue. Are those statistically detectable heterogeneities of any practical relevance when it comes to supporting monetary policy decision-making? To provide an answer to this question, we compute simple optimal monetary policy reaction functions on the basis of either an aggregate model or a disaggregate one, and compare the associated welfare losses. The results suggest that the welfare under-performance of an area-wide-model-based rule is not only nonnegligible, but also robust with respect to a number of sensitivity analyses.

Optimal monetary policy in the euro area in the presence of heterogeneity

“…The importance of considering national information when the central bank of the European monetary union decides on monetary policy has been studied empirically by De Grauwe (2000), De Grauwe and Piskorski (2001), Angelini et al (2002) and Monteforte and Siviero (2002). In particular, the authors evaluate, using the framework proposed by Rudebusch and Svensson (1999), the performance (relative loss) of rules targeting national variables as opposed to union-wide variables for calibrated aggregate demand and supply equations and all but De Grauwe and Piskorski (2001) find that the first type of rule may deliver large welfare gains.…”

Euro Area Income and Wealth Effects: Aggregation Issues*

“…We show that estimated MPCs and forecasts indirectly constructed by aggregating the countryspecific outcomes (hereafter indirect estimates/forecasts) are close to those using directly the data at the aggregated euro area level (direct estimates/forecasts). What is new compared to other studies reporting on country aggregation bias (Pesaran, and Smith, 1995;Marcellino et al, 2003;Ruth, 2008;Flavin et al, 2009;Monteforte and Siviero, 2010) is that our application uses a large number of private consumption model specifications rather than focus on one or a few specifications. In addition, other studies (Monteforte, 2007;Zeng, 2016) illustrate the country aggregation bias by aggregating across the three largest euro area countries, whereas we aggregate across the four largest euro area countries (hereafter EA4).…”

Welfare‐theoretic Optimal Policies in a New‐Keynesian Economy with Heterogeneous Regions: Any Role for Financial Integration?

“…It has been widely argued that in union‐wide environments, policies which take into account area‐wide outcomes, and therefore underestimate the performance of individual regions, can generate large welfare losses. Rudebusch and Svensson (); De Grauwe (); Angelini et al () and Monteforte and Siviero () present empirical evidence, with reference to the Economic and Monetary Union (EMU), that policies which target country‐specific variables prove to be significantly welfare‐improving, as opposed to their area‐wide equivalents. Jondeau and Sahuc () confirm this conclusion and point out that welfare losses become larger in the presence of heterogeneity of price‐indexation.…”