Professor of Economics
The big question for monetary policy in the European Economic and Monetary Union is whether common policy can be appropriate for the eleven countries in the union. This paper addresses the question from three different perspectives.First, to what extent is common policy made feasible by the degree of synchronization of business cycles? Preliminary evidence suggests that economic activity across EMU countries has become more correlated in the 1990s. Second, are there asymmetries in the mechanisms through which policy affects economic activity?To answer this question, the author investigates the relationship between the documented heterogeneity in policy transmission and conventional measures of the strength of the propagation mechanism. The results speak in favor of a credit channel, as key financial factors explain very well cross-country differences in the response of output to a monetary policy shock. Third, how is policy implemented in an environment of diverse business cycle fundamentals and transmission mechanisms? To answer this question, the author discusses the targeting framework of the European Central Bank and estimates a modification of the forward-looking reaction function studied by Clarida, Gali and Gertler (2000).This paper argues that the ECB is closer to an aggregate of the central banks in Germany, France, and Italy than to the Bundesbank alone.