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Eva Ortega

30 June 2025

OCCASIONAL PAPER SERIES - No. 371

A strategic view on the economic and inflation environment in the euro area

English

22 October 2024

OCCASIONAL PAPER SERIES - No. 357

Using structural models to understand macroeconomic tail risks

English

Abstract: Understanding asymmetric risks in macroeconomic variables is challenging. Most structural models used for policy analysis are linearised and therefore cannot generate asymmetries such as those documented in the empirical growth-at-risk (GaR) literature. This report examines how structural models can incorporate non-linearities to generate tail risks. The first part reviews the various extensions to dynamic stochastic general equilibrium (DSGE) models and the computational challenges involved in accounting for risk distributions. This includes the use of occasionally binding constraints and more recent developments, such as deep learning, to solve non-linear versions of DSGEs. The second part shows how the New Keynesian DSGE model, augmented with the vulnerability channel as proposed by Adrian et al. (2020a, b), satisfactorily replicates key empirical facts from the GaR literature for the euro area. Furthermore, introducing a vulnerability channel into an open-economy set-up and a medium-sized DSGE highlights the importance of foreign financial shocks and financial frictions, respectively. Other non-linearities arising from financial frictions are also addressed, such as borrowing constraints that are conditional on an asset’s value, and the way macroprudential policies acting against those constraints can help stabilise the economy and generate positive spillovers to monetary policy. Finally, the report examines how other types of tail risk beyond financial frictions – such as the recent asymmetric supply-side shocks – can be incorporated into macroeconomic models used for policy analysis.
JEL Code: E70 : Macroeconomics and Monetary Economics
D50 : Microeconomics→General Equilibrium and Disequilibrium→General
G10 : Financial Economics→General Financial Markets→General
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

11 May 2020

ECONOMIC BULLETIN - ARTICLE

The transmission of exchange rate changes to euro area inflation

Economic Bulletin Issue 3, 2020

English

Abstract: Aggregate exchange rate pass-through (ERPT) to import and consumer prices is lower in the EU than it was in the 1990s and is found to be non-linear. Low estimated aggregate ERPT to consumer prices does not mean that the exchange rate movements do not matter for inflation, as aggregate estimates mask substantial heterogeneities across countries, industries and time periods due to structural, cyclical and policy factors. Key structural characteristics that explain ERPT across industries or sectors are: import content of consumption; share of imports invoiced in own currency or in a third dominant currency; integration of a country and its trading partners in global value chains; and market power. In line with the literature, different types of shocks that move the exchange rate in the euro area elicit different price responses, so the combination of shocks that lie behind changes in the exchange rate at any point in time matters for the ERPT. Finally, monetary policy itself affects the ERPT and credible and active monetary policy lowers the observed ex post ERPT. Moreover, under the effective lower bound, credible non-standard monetary policy actions have a larger ERPT to consumer prices. Instead of rules of thumb, in order to assess the impact of exchange rate changes when forecasting inflation, it is better to use structural models with sufficient feedback loops that take into account the role of expectations and monetary policy reaction., share of imports invoiced in own currency or in a third dominant currency, integration of a country and its trading partners in global value chains, and market power. In line with the literature, different types of shocks that move the exchange rate in the euro area elicit different price responses, so the combination of shocks that lie behind changes in the exchange rate at any point in time matters for the ERPT. Finally, monetary policy itself affects the ERPT and credible and active monetary policy lowers the observed ex post ERPT. Moreover, under the effective lower bound, credible non-standard monetary policy actions have a larger ERPT to consumer prices. Instead of rules of thumb, in order to assess the impact of exchange rate changes when forecasting inflation, it is better to use structural models with sufficient feedback loops that take into account the role of expectations and monetary policy reaction.
JEL Code: E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
F31 : International Economics→International Finance→Foreign Exchange
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

22 April 2020

OCCASIONAL PAPER SERIES - No. 241

Exchange rate pass-through in the euro area and EU countries

English

Abstract: Aggregate exchange rate pass-through (ERPT) to import and consumer prices in the EU is currently lower than it was in the 1990s and is non-linear. Low estimated aggregate ERPT to consumer prices does not at all mean that exchange rate movements do not have an impact on inflation, as aggregate rules of thumb mask substantial heterogeneities across countries, industries and time periods owing to structural, cyclical and policy factors. Looking also at new micro evidence, four key structural characteristics explain ERPT across industries or sectors: (i) import content of consumption, (ii) share of imports invoiced in own currency or in a third dominant currency, (iii) integration of a country and its trading partners in global value chains, and (iv) market power. In the existing literature there is also a robust evidence across models showing that each shock which causes the exchange rate to move has a different price response, meaning that the combination of shocks that lies behind the cycle at any point in time has an impact on ERPT.Finally, monetary policy itself affects ERPT. Credible and aggressive monetary policy reduces the observed ex post ERPT, as agents expect monetary policy to counteract deviations of inflation from target, including those relating to exchange rate fluctuations. Moreover, under the effective lower bound, credible non-standard monetary policy actions result in greater ERPT to consumer prices. This paper recommends moving away from rule-of-thumb estimates and instead using structural models with sufficient feedback loops, taking into account the role of expectations and monetary policy reactions, to assess the impact of exchange rate changes when forecasting inflation.
JEL Code: C50 : Mathematical and Quantitative Methods→Econometric Modeling→General
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
F31 : International Economics→International Finance→Foreign Exchange
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

25 March 2020

WORKING PAPER SERIES - No. 2383

Exchange rate shocks and inflation comovement in the euro area

English

Abstract: This paper decomposes the time-varying effect of exogenous exchange rate shocks on euro area countries inflation into country-specific (idiosyncratic) and region-wide (common) components. To do so, we propose a flexible empirical framework based on dynamic factor models subject to drifting parameters and exogenous information. We show that exogenous shocks to the EUR/USD exchange rate account for over 50% of nominal EUR/USD exchange rate fluctuations in more than a third of the quarters of the past six years, especially in turning point periods. Our main results indicate that headline inflation in euro area countries, and in particular its energy component, has become significantly more affected by these exogenous exchange rate shocks since the early 2010s, in particular for the region's largest economies. While in the case of headline inflation this increasing sensitivity is solely reliant on a sustained surge in the degree of comovement, for energy inflation it is also based on a higher region-wide effect of the shocks. By contrast, purely exogenous exchange rate shocks do not seem to have a significant impact on the core component of headline inflation, which also displays a lower degree of comovement across euro area countries.
JEL Code: C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
F31 : International Economics→International Finance→Foreign Exchange
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics

25 February 2013

OCCASIONAL PAPER SERIES - No. 143

Financial shocks and the macroeconomy: heterogeneity and non-linearities

English

Abstract: This paper analyses the transmission of financial shocks to the macro-economy. The role of macro-financial linkages is investigated from an empirical perspective for the euro area as a whole, for individual euro area member countries and for other EU and OECD countries. The following key economic questions are addressed: 1) Which financial shocks have the largest impact on output over the full sample on average? 2) Are financial developments leading real activity? 3) Is there heterogeneity or a common pattern in macro-financial linkages across the euro area and do these linkages vary over time? 4) Do cross-country spillovers matter? 5) Is the transmission of financial shocks different during episodes of high stress than it is in normal times, i.e. is there evidence of non-linearities? In summary, it is found that real asset prices are significant leading indicators of real activity whereas the latter leads loan developments. Furthermore, evidence is presented that macro-financial linkages are heterogeneous across countries
JEL Code: C43 : Mathematical and Quantitative Methods→Econometric and Statistical Methods: Special Topics→Index Numbers and Aggregation
D11 : Microeconomics→Household Behavior and Family Economics→Consumer Economics: Theory

28 November 2012

WORKING PAPER SERIES - No. 1498

Heterogeneity and cross-country spillovers in macroeconomic-financial linkages

English

Abstract: We investigate heterogeneity and spillovers in macro-financial linkages across developed economies, with a particular emphasis in the most recent recession. A panel Bayesian VAR model including real and financial variables identifies a statistically significant common component, which turns out to be very significant during the most recent recession. Nevertheless, countryspecific factors remain important, which explains the heterogeneous behaviour across countries observed over time. Moreover, spillovers across countries and between real and financial variables are found to matter: A shock to a variable in a given country affects all other countries, and the transmission seems to be faster and deeper between financial variables than between real variables. Finally, shocks spill over in a heterogeneous way across countries.
JEL Code: C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General
C33 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Panel Data Models, Spatio-temporal Models
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
F44 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Business Cycles

22 June 2011

WORKING PAPER SERIES - No. 1357

Assessing the sensitivity of inflation to economic activity

English

Abstract: A number of academic studies suggest that from the mid-1990s onwards there were changes in the link between inflation and economic activity. However, it remains unclear the extent to which this phenomenon can be ascribed to a change in the structural relationship between inflation and output, as opposed to a change in the size and nature of the shocks hitting the economy. This paper uses a suite of models, such as time-varying VAR techniques, traditional macro models, as well as DSGE models, to investigate, for various European countries as well as for the euro area, the evolution of the link between inflation and resource utilization and its dependence on the nature and size of the shocks. Our analysis suggests that the relationship between inflation and activity has indeed been changing over time, while remaining positive, with the correlation peaking during recessions. Quantitatively, the link between output and inflation is found to be highly dependent on which type of shocks hit the economy: while, in general, all demand shocks to output imply a reaction of inflation of the same sign, the latter will be less pronounced when output fluctuations are driven by supply shocks. In addition, a sharp deceleration of activity, as opposed to a subdued but protracted slowdown, results in a swifter decline in inflation. Inflation exhibits a rather strong persistence, with a negative impact still visible three years after the initial shock.
JEL Code: E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E37 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Forecasting and Simulation: Models and Applications

27 February 2004

WORKING PAPER SERIES - No. 312

English

Abstract: This paper examines the properties of G-7 cycles using a multicountry Bayesian panel VAR model with time variations, unit specific dynamics and cross country interdependences. We demonstrate the presence of a significant world cycle and show that country specific indicators play a much smaller role. We detect diﬀerences across business cycle phases but, apart from an increase in synchronicity in the late 1990s, find little evidence of major structural changes. We also find no evidence of the existence of an Euro area specific cycle or of its emergence in the 1990s.
JEL Code: C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General
C33 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Panel Data Models, Spatio-temporal Models
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

Eva Ortega

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