country shocks, monetary policy expectations and ecb

COUNTRY SHOCKS, MONETARY POLICY EXPECTATIONS AND ECB DECISIONS. A DYNAMIC NON-LINEAR APPROACH

Maximo Camacho, Danilo Leiva-Leon and Gabriel Perez-Quiros

Documentos de Trabajo N.º 1523

2015

COUNTRY SHOCKS, MONETARY POLICY EXPECTATIONS

AND ECB DECISIONS. A DYNAMIC NON-LINEAR APPROACH

Documentos de Trabajo. N.º 1523

2015

(*) We thank participants at the Advances in Econometrics Conference on Dynamic Factor Models in Aahrus and the two anonymous referees. Maximo Camacho thanks CICYT for its support through grant ECO2013-45698. The views expressed in this paper are those of the authors and do not represent the views of the Central Bank of Chile, Airef, the Banco de España or the Eurosystem.(**) [email protected].(***) [email protected].(****) [email protected].

Maximo Camacho (**)

UNIVERSITY OF MURCIA

Danilo Leiva-Leon (***)

CENTRAL BANK OF CHILE

Gabriel Perez-Quiros (****)

BANCO DE SPAÑA, AIREF AND CEPR

COUNTRY SHOCKS, MONETARY POLICY EXPECTATIONS

AND ECB DECISIONS. A DYNAMIC NON-LINEAR APPROACH (*)

The Working Paper Series seeks to disseminate original research in economics and fi nance. All papers have been anonymously refereed. By publishing these papers, the Banco de España aims to contribute to economic analysis and, in particular, to knowledge of the Spanish economy and its international environment.

The opinions and analyses in the Working Paper Series are the responsibility of the authors and, therefore, do not necessarily coincide with those of the Banco de España or the Eurosystem.

The Banco de España disseminates its main reports and most of its publications via the Internet at the following website: http://www.bde.es.

Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.

© BANCO DE ESPAÑA, Madrid, 2015

ISSN: 1579-8666 (on line)

Abstract

Previous studies have shown that the effectiveness of monetary policy largely depends

on market expectations about future policy actions. This paper proposes an econometric

framework to address the effect of the current state of the economy on monetary policy

expectations. Specifi cally, we study the effect of contractionary (or expansionary) demand

(or supply) shocks hitting the euro area countries on the expectations about the ECB’s

monetary policy in two stages. In the fi rst stage, we construct indices of real activity and

infl ation dynamics for each country, based on soft and hard indicators. In the second stage,

we use those indices to provide assessments of the type of aggregate shock hitting each

country and assess its effect on monetary policy expectations at different horizons. Our

results indicate that expectations are responsive to aggregate contractionary shocks, but

not to expansionary shocks. In particular, contractionary demand shocks have a negative

effect on short-term monetary policy expectations, while contractionary supply shocks have

a negative effect on medium and long-term expectations. Moreover, shocks to different

economies do not have signifi cantly different effects on expectations, although some cross-

country differences arise.

Keywords: business cycles, infl ation cycles, monetary policy.

JEL classifi cation: E32, C22, E27.

Resumen

Algunos trabajos han mostrado que la efectividad de la política monetaria depende, en gran

medida, de las expectativas que el Mercado tiene de las futuras acciones de política. Este

documento propone un marco econométrico que determina el efecto del ciclo económico

sobre estas futuras acciones de política. Específi camente, analizamos el efecto de unos

shocks de demanda (u oferta) contractivos (o expansivos) sobre las expectativas de las

futuras decisiones de política monetaria. Este análisis lo hacemos en dos etapas. En una

primera etapa, construimos índices de actividad real e infl ación para cada país basados

en la evolución de indicadores reales y de opinión. En una segunda etapa, utilizamos esos

índices para determinar el tipo de shock que afecta a la economía y sus efectos sobre

expectativas de política monetaria a diferentes horizontes. Nuestros resultados indican que

las expectativas responden a shocks agregados contractivos, pero no a shocks expansivos.

Particularmente, los shocks de demanda contractivos tienen un efecto negativo sobre

las expectativas de política monetaria en el corto plazo, mientras que shocks de oferta

contractivos tienen efecto en el medio-largo plazo. Por último, mostramos que shocks

en diferentes economías del área del euro no producen reacciones signifi cativamente

diferentes, aunque aparecen algunas diferencias entre países.

Palabras clave: ciclos económicos, ciclos de infl ación, política monetaria.

Códigos JEL: E32, C22, E27.

BANCO DE ESPAÑA 7 DOCUMENTO DE TRABAJO N.º 1523


Table 1. Parameter estimates coefficients of equation (12)

Germany France Italy Spain

-2,56 -1,50 -5,12 -3,37 (0,55) (0,39) (0,39) (0,26)

2,89 1,65 6,62 3,66 (0,46) (0,39) (0,40) (0,26)

-3,74 -2,93 -3,03 -2,19 (0,54) (0,37) (0,31) (0,31)

4,10 3,25 3,81 2,40 (0,50) (0,35) (0,31) (0,30)

0,98 0,97 0,97 0,98 (0,02) (0,02) (0,01) (0,01)

0,84 0,79 0,91 0,84 (0,08) (0,09) (0,04) (0,08)

0,98 0,97 0,98 0,97 (0,01) (0,02) (0,01) (0,01)

0,83 0,79 0,91 0,80 (0,08) (0,08) (0,05) (0,09)

0,99 0,98 0,98 0,98 (0,01) (0,01) (0,01) (0,01)

0,81 0,78 0,85 0,80 (0,09) (0,09) (0,07) (0,09)

0,84 0,86 0,87 0,82 (0,10) (0,10) (0,09) (0,11)

0,92 0,88 0,96 0,90 (0,08) (0,10) (0,03) (0,07)

2,28 1,15 5,90 0,89 (0,33) (0,16) (0,65) (0,10)

2,26 1,09 2,31 0,82 (0,30) (0,14) (0,26) (0,10)

-0,25 -0,05 0,91 0,07 (0,46) (0,13) (0,36) (0,07)

Notes.Parameter estimates for the coefficients of the two means, of each factor, transition probabilities of the MS models and variance covariance matrices. Factor "a" relates to real activity while factor "b" relates to inflation developments. Standard errors are in parenthesis.

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Figure 1. Real Activity and Inflation Indexes

Notes. The figure plots the real activity index (blue solid line) and the inflation index (red dashed line) for each country.

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Italy Spain

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Figure 2. Regime inferences of Real Activity and Inflation

Notes. Each chart plots the probability of low mean (solid red line) and the corresponding index (dashed blue line).

Probability of low real activity in Germany

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Probability of low inflation in Germany

Probability of low real activity in France Probability of low inflation in France

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Figure 2. Regime inferences of Real Activity and Inflation (cont.)

Notes. Each chart plots the probability of low mean (solid red line) and the corresponding index (dashed blue line).

Probability of low real activity in Italy Probability of low inflation in Italy

Probability of low real activity in Spain Probability of low inflation in Spain

00,10,20,30,40,50,60,70,80,91

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Figure 2B. Regime inferences of Real Activity and Inflation

Notes. Top charts plots the probabilities of low real activity and of low inflation. Bottom charts shows their synchronization.

Low real activity and low inflation in Germany

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Figure 2B. Regime inferences of Real Activity and Inflation (Cont)

Notes. Top charts plots the probabilities of low real activity and of low inflation. Bottom charts shows their synchronization.

Low real activity and low inflation in Italy Low real activity and low inflation in Spain

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Figure 3. Regime inferences on aggregate shocks in Germany

Notes. Each chart plots the probability of aggregate shocks (double red line) and the main refinancing operations: minimum bid rate in first differenced (solid blue line).

Probability of expansionary demand shocks Probability of expansionary supply shocks

Probability of contractionary supply shocks Probability of contractionary demand shocks

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Figure 4. Regime inferences on aggregate shocks in France




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Figure 5. Regime inferences on aggregate shocks in Italy




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M02

2002

M09

2003

M04

2003

M11

2004

M06

2005

M01

2005

M08

2006

M03

2006

M10

2007

M05

2007

M12

2008

M07

2009

M02

2009

M09

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2011

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2012

M01

2012

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2013

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M10


-0,8-0,6-0,4-0,2

00,20,40,60,8

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1999

M03

1999

M10

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M05

2000

M12

2001

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2002

M02

2002

M09

2003

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2003

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2004

M06

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M01

2005

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2006

M03

2006

M10

2007

M05

2007

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2008

M07

2009

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2009

M09

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M04

2010

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2012

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00,20,40,60,8

1

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M03

1999

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2000

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Figure 6. Regime inferences on aggregate shocks in Spain




-0,8-0,6-0,4-0,2

00,20,40,60,8

119

99M

0319

99M

1020

00M

0520

00M

1220

01M

0720

02M

0220

02M

0920

03M

0420

03M

1120

04M

0620

05M

0120

05M

0820

06M

0320

06M

1020

07M

0520

07M

1220

08M

0720

09M

0220

09M

0920

10M

0420

10M

1120

11M

0620

12M

0120

12M

0820

13M

0320

13M

10


-0,8-0,6-0,4-0,2

00,20,40,60,8

1

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M03

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00,20,40,60,8

1

1999

M03

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Figure 7. Effects of aggregate shocks in Germany on monetary policy expectations

Notes. In each chart the vertical axis represents the effect of a specific aggregate shock on monetary policy expectations at different horizons (blue dashed line). Horizontal axis represents the horizon of expectations in years. The red bands (fan chart) represent up to the 0.90 quantile of the corresponding estimate’s distribution, as a measure of uncertainty.

Effect of expansionary demand shocks Effect of expansionary supply shocks

Effect of contractionary supply shocks Effect of contractionary demand shocks

2 4 6 8 10 12 14 16

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-0.05

0

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2 4 6 8 10 12 14 16

-0.15

-0.1

-0.05

0

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2 4 6 8 10 12 14 16

-0.15

-0.1

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0

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2 4 6 8 10 12 14 16

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2 4 6 8 10 12 14 16-0.2

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2 4 6 8 10 12 14 16-0.2

-0.15

-0.1

-0.05

0

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0.1

2 4 6 8 10 12 14 16-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

2 4 6 8 10 12 14 16-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

Figure 8. Effects of aggregate shocks in France on monetary policy expectations

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2 4 6 8 10 12 14 16

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2 4 6 8 10 12 14 16

-0.15

-0.1

-0.05

0

0.05

2 4 6 8 10 12 14 16

-0.15

-0.1

-0.05

0

0.05

2 4 6 8 10 12 14 16

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-0.05

0

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Figure 9. Effects of aggregate shocks in Italy on monetary policy expectations

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2 4 6 8 10 12 14 16-0.25

-0.2

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-0.05

0

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0.1

0.15

2 4 6 8 10 12 14 16-0.25

-0.2

-0.15

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0

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0.15

2 4 6 8 10 12 14 16-0.25

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-0.05

0

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2 4 6 8 10 12 14 16-0.25

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-0.05

0

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0.1

0.15

Figure 10. Effects of aggregate shocks in Spain on monetary policy expectations

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