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The authors thank, without implicating, Graham Hacche, Alex Hoffmaister, Paul Masson, Donogh McDonald, Guy Meredith, and Eswar Prasad for comments on an earlier version of this paper.
In this context, a recent study using higher frequency data by Levy and Halikias (1997) indicates that the response of output to changes in the short-term interest rate in France is relatively muted.
A good example of popular perceptions about the transmission mechanism in the EU countries is CEPR (1997), which argues that the impact of an interest rate shock on output would be disproportionately large in the UK because a relatively high proportion of private sector debt is at variable interest rates, partly reflecting the predominance of variable-rate mortgages for house purchase.
The empirical analysis in this paper covers all EU countries except Greece, Luxembourg and Ireland. These three countries were excluded because of the absence of a sufficiently long quarterly time series of national income accounts.
The monetary shock is of the same dimension for all the countries--a one standard deviation shock to the orthogonalized error term of the interest rate equation in the VAR. It corresponds approximately to a 1 percentage point shock to the interest rate for most EU countries in the sample period under consideration. See Appendix for details on how the monetary shock is measured. The focus of this paper is on the response of output to monetary shocks, and not also on the response of prices to monetary shocks. This is done in order to keep the scope of cross-country comparisons of the transmission mechanism more focused, and also because we do not want to enter in this paper into a detailed discussion of the so-called “price puzzle” for the entire set of EU countries. The price puzzle is the tendency for prices to rise immediately following a contractionary monetary shock; see Leeper, Sims, and Zha (1996) for a more detailed discussion of issues pertaining to the price puzzle.
See Bayoumi and Eichengreen (1996) for an overview of the discussion on asymmetric shocks in the EU.
For discussions regarding the emerging consensus on the real effects of monetary shocks, see Bernanke and Gertler (1995); Taylor (1995); and the symposium on “Is There a Core of Practical Macroeconomics that We Should All Believe In” in the American Economic Review, Papers and Proceedings, May 1997,
See Bernanke and Gertler for a discussion of the “credit-view” (1995).
The impulse response function estimated with the three variable VAR for Sweden is broadly consistent with the results obtained by Thomas (1997), using a simulation model of the IS/LM variety for Sweden.
A number of empirical studies of the transmission mechanism have tended to follow the route of estimating VARs that are unrestricted in levels. See for instance Bernanke and Blinder (1992), Christiano, Eichenbaum and Evans (1994) and Leeper, Sims, and Zha (1996). In this context, Faust and Leeper (1997) argue that imposing long-run restrictions does not necessarily provide a reliable basis for drawing structural inferences.
The nominal exchange rate used is the bilateral deutsche mark exchange rate for all countries. In the case of Germany, the bilateral dollar exchange rate is used.
Actually two identification schemes are suggested in Bernanke and Blinder (1992), we however only focus on the scheme where there is no contemporaneous effect of monetary policy on output. Their other identification scheme suggests that the policy variable does not respond contemporaneously to changes in the non-policy variables.