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Optimal Monetary Policy in an Estimated DSGE Model of the Euro Area with Cross-country Heterogeneity

Author

Listed:
  • Eric Jondeau

    (HEC Lausanne and FAME)

  • Jean-Guillaume Sahuc

    (Banque de France and EPEE, University of Evry)

Abstract
We investigate the implications of cross-country heterogeneity within the euro area for the design of optimal monetary policy. We build an optimizing-based multi-country model (MCM) describing the euro area in which differences between structural parameters across countries are allowed. Using Bayesian techniques, we estimate the MCM and its area-wide counterpart (AWM) and compare their empirical performances. We then question which model is the most appropriate for monetary policy purposes. We find that using an AWM induces relatively large and significant welfare losses. Our results also suggest that this is not the use of a rule based on aggregated variables that is costly in terms of welfare, but rather the use of a sub-optimal forecasting model.

Suggested Citation

  • Eric Jondeau & Jean-Guillaume Sahuc, 2004. "Optimal Monetary Policy in an Estimated DSGE Model of the Euro Area with Cross-country Heterogeneity," Documents de recherche 04-13, Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne.
    • Handle: RePEc:eve:wpaper:04-13
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    More about this item

    Keywords

    Euro area; heterogeneity; optimal monetary policy; Bayesian econometrics;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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