Monetary Aggregates, Long-Term Interest Rates and the Monetary Transmission Mechanism in the Euro Area
(English)Manuscript (Other academic)
Between 2001 and 2004 massive portfolio shifts took place in the Euro area from equity to money balances. The European Central Bank (ECB, 2004) suggests that this was caused by heightened risk aversion in the wake of financial market instability. Although the relation between these portfolio shifts and movements in equity prices has been investigated (see ECB, 2003), there are no studies focusing on government bonds. In this paper, I consider the relation between money demand shocks and bond yields. I use Bayesian methods to estimate the general-equilibrium model of Marzo, Söderström and Zagaglia (2008) where bond prices are an integral part of the monetary transmission mechanism. I show that taking into account the impact of bond yields on the macroeconomy generates superior in-sample and out-of-sample forecasts for output, inflation and for bond yields. I also find that, besides shocks to monetary policy and the inflation target, money demand shocks matter for explaining the dynamics of long-term interest rates.
Research subject Economics
IdentifiersURN: urn:nbn:se:su:diva-27651OAI: oai:DiVA.org:su-27651DiVA: diva2:216721
ProjectsMonetary policy, yield curve, term premia