The effect of the ECB’s conventional monetary policy on the real economy: FAVAR-approach

Abstract

This study applies factor-augmented vector autoregressive models to investigate the effect of the European Central Bank’s (ECB) conventional monetary policy on the real economy. More specifically, the study examines how unanticipated changes in the ECB’s policy rate have affected unemployment rate and industrial production. The effect of monetary policy on unemployment rate and industrial production is estimated to be strong and statistically significant using the data from January 1999 to July 2017 or from the pre-crisis period. However, after the beginning of the crisis the responses weaken drastically and become sometimes statistically insignificant, indicating that the effect of the ECB’s conventional monetary policy became weaker after the financial crisis. This finding is extremely interesting because one could presume either weaker or stronger effect based on economic theory. Additionally, the previous studies that have analysed the possible changes in the monetary policy effectiveness in the euro area have not found any changes (e.g. Bagzibagli in Empir Econ 47(3):781–823, 2014; Von Borstel et al. in Int J Money Finance 68:386–402, 2016).