Monetary Spillovers from the United States to the Euro Area.Empirical Evidence from Bayesian Vector Autoregression

Abstract

This work identifes monetary policy shocks in the United States and explores their economic implications for the Euro Area in a two-country Vector Autoregressive framework that is estimated with Bayesian techniques. In particular, this work explicitly explores the implications for European prices, production and interest rates while allowing the shocks to transmit through global commodity prices, the nominal exchange rate and the bilateral trade balance. The main empirical findings suggest that monetary policy has sizeable implications for the domestic economy but the direct effect of monetary spillovers on the receiving economy is somewhat limited. In particular, positive interest rate spillovers originating in the United States are found to have only a modest negative impact on European production whereas the price effect is negligible. Interestingly, the European Central Bank is found to respond in a similar fashion thereby translating the foreign disturbance into domestic policy. The contribution of this work is twofold. First, it provides empirical evidence for the impact of international monetary spillovers originating in the United States on the Euro Area as the receiving economy as well as their transmission channels. Second, the conceptual framework allows for an empirical comparison to monetary spillover effects generated in a contemporary general equilibrium model.