Matteo Ciccarelli

Estimating Multicountry VAR Models

This article presents a method to estimate the coefficients, to test specification hypotheses, and to conduct policy exercises in multicountry Vector Autoregressive (VAR) models with cross-unit interdependencies, unit-specific dynamics, and time variations in the coefficients. The framework of analysis is Bayesian: A prior flexibly reduces the dimensionality of the model and puts structure on the time variations, Markov chain Monte Carlo (MCMC) methods are used to obtain posterior distributions, and marginal likelihoods to check the fit of various specifications. Impulse responses and conditional forecasts are obtained with the output of an MCMC routine. The transmission of certain shocks across countries is analyzed.

Trusting the bankers: A new look at the credit channel of monetary policy☆

Monetary policy has real effects through credit supply and demand, and since these changes are mostly unobserved, the complete identification of the credit channel is generally unfeasible. Bank lending surveys by central banks, however, contain reliable quarterly information on changes in loan conditions due to bank, firm and household balance sheet strength and on changes in loan demand. Using the U.S. and the unique Euro area surveys, we find that the credit channel amplifies a monetary policy shock on GDP and prices through the balance-sheets of households, firms and banks. For corporate loans, amplification is highest through the bank lending and the borrowers balance sheet channel; for households, demand is the strongest channel (Copyright: Elsevier)

Forecasting and Turning Point Predictions in a Bayesian Panel VAR Model

We provide methods for forecasting variables and predicting turning points in panel Bayesian VARs. We specify a flexible model which accounts for both interdependencies in the cross section and time variations in the parameters. Posterior distributions for the parameters are obtained for a particular type of diffuse, for Minnesota-type and for hierarchical priors. Formulas for multistep, multiunit point and average forecasts are provided. An application to the problem of forecasting the growth rate of output and of predicting turning points in the G-7 illustrates the approach. A comparison with alternative forecasting methods is also provided.

Price setting and inflation persistence: did EMU matter?

Surprisingly it did not, or at least not directly. Using micro data on consumer prices and sectoral inflation rates from 6 euro area countries, spanning several years before and after the introduction of the euro, we look at whether EMU has altered the behaviour of retail price setting and/or inflation dynamics. We find no evidence that anything has changed around 1999 - if anything, persistence may have slightly increased. At the end of 2001 and in the beginning of 2002 (period surrounding the euro cash changeover) retail price adjustment frequencies, both up and down, increased substantially, while the magnitude of the price adjustment, also both up and down, was smaller than otherwise. However, both settled quickly back to the earlier patterns. On the contrary, we do find evidence of a decline in the persistence of the inflation process in the mid-1990s. This could be due to a structural change in private inflationary expectations due, at least in part, to policies linked to the preparation of EMU; however, this interpretation is weakened by the fact that a similar decline occurred also in the US.

Heterogeneous Transmission Mechanism: Monetary Policy and Financial Fragility in the Eurozone

The Euro area economic activity and banking sector have shown substantial fragility over the last years with remarkable country heterogeneity. Using detailed data on lending conditions and standards, we analyse how financial fragility has affected the transmission mechanism of the single Euro area monetary policy during the crisis until the end of 2011. The analysis shows that the monetary transmission mechanism has been time-varying and influenced by the financial fragility of the sovereigns, banks, firms and households. The impact of monetary policy on aggregate output is stronger during the financial crisis, especially in countries facing increased sovereign financial distress. This amplification mechanism, moreover, operates mainly through the credit channel, both the bank lending and the non-financial borrower balance-sheet channel. Our results suggest that the bank-lending channel has been partly mitigated by the ECB nonstandard monetary policy interventions. At the same time, when looking at the transmission through banks of different sizes, it seems that, until the end of 2011, the impact of credit frictions of borrowers have not been significantly reduced, especially in distressed countries. Since small banks tend to lend primarily to SME, we infer that the policies adopted until the end of 2011 might have fall short of reducing credit availability problems stemming from deteriorated firm net worth and risk conditions, especially for small firms in countries under stress. JEL Classification: E44, E52, E58, G01, G21, G28

Bayesian VARs: A Survey of the Recent Literature with an Application to the European Monetary System

This paper reviews recent advances in the specification and estimation of Bayesian Vector Autoregressive models (BVARs). After describing the Bayesian principle of estimation, we first present the methodology originally developed by Litterman (1986) and Doan et al. (1984) and review alternative priors. We then discuss extensions of the basic model and address issues in forecasting and structural analysis. An application to the estimation of a system of time-varying reaction functions for four European central banks under the European Monetary System (EMS) illustrates how some of the results previously presented may be applied in practice.

Measuring Contagion with a Bayesian, Time-Varying Coefficient Model

We propose using a Bayesian time-varying coefficient model estimated with Markov chain-Monte Carlo methods to measure contagion empirically. The proposed measure works in the joint presence of heteroskedasticity and omitted variables and does not require knowledge of the timing of the crisis. It distinguishes contagion not only from interdependence but also from structural breaks and can be used to investigate positive as well as negative contagion. The proposed measure appears to work well using both simulated and actual data.

Low inflation in the euro area: Causes and consequences

Euro area inflation remained unexpectedly weak between 2012 and 2016. This was surprising as the region’s ongoing economic recovery was expected to stimulate inflation. Persistently low inflation begs a great many questions: What are the underlying factors? Are the economic models used to predict inflation fit for purpose? Do falling inflation expectations point to a real “de-anchoring” from the inflation target? How can monetary policy combat weak inflation and its related risks? Should monetary policy be supported by other policy domains? The Eurosystem has introduced a whole range of unconventional measures, including an asset purchase programme, with the aim of getting inflation back to its target of below, but close to 2%. To gain a full and comprehensive understanding of the complex issues underlying low inflation, it also set up the Low Inflation Task Force (LIFT) with a brief to investigate the above questions. The article discusses its main findings (see Ciccarelli and Osbat, 2017), which in short suggest that: Inflation in the euro area has been held back chiefly by cyclical forces. More specifically, domestic shocks caused inflation to fall in the 2012-14 period, following which foreign shocks gained importance, e.g. the prolonged decline in oil prices. Traditional models – and more specifically the Phillips curve, which captures the relationship between domestic economic activity and inflation – continue to be relevant for understanding and predicting inflation dynamics. There was a real threat of inflation expectations becoming de-anchored, and the asset purchase programme proved justified. De-anchoring may result from declining confidence in both the effectiveness of monetary policy and the inflation target. The asset purchase programme has proved successful as it has supported inflation, fostering its return to target in good time, and it has also contributed to re-anchoring inflation expectations. Monetary policy can benefit from positive interactions with measures in other policy domains – e.g. structural reforms and budgetary policies – and particularly so in an environment where policy rates are close to their lower bound.

Commonalities and cross-country spillovers in macroeconomic-financial linkages

Abstract In this paper, we investigate commonalities and spillovers in macro-financial linkages across developed economies. A Bayesian panel vector autoregression (VAR) model with real and financial variables identifies significant common components, especially during the Great Recession. Nevertheless, country-specific factors remain important, which is consistent with the heterogeneous behavior observed across countries over time. We also find that spillovers across countries and between real and financial variables are key to explain economic fluctuations. 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. For a shock to a financial variable to have a noticeable effect on the real economy elsewhere, it needs to be either common to all countries or to have originated in a systemic country.