Post-COVID Exogenous and Endogenous ECB Monetary Policy I

NIESR’s Analysis

The National Institute of Economic and Social Research, or NiGEM, has developed a new simulation that simulates the effects of unexpected increases in US and Euro Area interest rates. We are examining the results of an exogenous, 1 percentage point increase in policy rates relative to the baselFine, with a focus on transmission channels and the size of the spillovers. The simulation results indicate that the Fed's influence on the Euro Area is significant. It affects financial conditions (such as bond rates) and economic activity, meaning output, through a weaker euro against a stronger US dollar. In most countries, lower domestic demand is counterbalanced by the positive contribution from the net trade as net exports increase. A restrictive monetary policy in the US in NiGEM would shift the Euro area's demand from domestic to foreign, thereby increasing pressure on production and prices.

Bilateral Spillovers Between the Euro Area and the United States

In NiGEM, ECB and Fed monetary policies have a significant influence on local financial conditions, real activity, and inflation. A surprise monetary policy tightening by the ECB or the Fed boosts domestic government and bond rates, depresses local equity markets, and causes the domestic currency to appreciate. Conversely, the impact of ECB monetary policy on the US economy is close to zero after five years.