Introduction

The purpose of this chapter is to analyse the monetary transmission mechanism in the euro area through the use of large-scale macroeconomic models at the disposal of the European Central Bank (ECB) and the National Central Banks (NCBs) of the Eurosystem. The results reported in this paper are the fruit of cooperation within the Working Group on Econometric Modelling (WGEM) and are based on a carefully designed common simulation experiment.

The last major study of comparative properties of central bank models in terms of monetary transmission was carried out by the BIS in 1994 (BIS, 1995). The experiment involved a one-percentage point increase in the policy interest rate for two years and the results were summarised by Smets (1995). There are a number of important reasons why it is timely to re-examine the transmission mechanism rather than relying on the BIS results. First, there is evidence that the monetary transmission mechanism may change considerably even in a short period of time. Second, it is now possible to undertake this experiment for all twelve members of the euro area rather than the eight EU countries included in the BIS exercise. In addition, a further new model that can now be used in such an exercise is the ECB's Area Wide Model (AWM) which is a model of the aggregate euro area economy (as detailed in Fagan, Henry and Mestre 2001).