The Aggregate and Country-Specific Effectiveness of ECB Policy: Evidence from an External Instruments VAR Approach

This 2020 International Journal of Central Banking paper by Lucas Hafemann and Peter Tillmann studies how ECB monetary policy transmits to the euro area as a whole and, separately, across individual member countries, using monthly data from 2002:M1 to 2016:M10 – a period spanning both conventional policy and unconventional measures (the asset purchase programme, TLTROs) during which short rates sat at the effective lower bound. Because the policy stance in this period is “no longer appropriately summarized by the short-term policy rate” and Cholesky or sign-restriction schemes are hard to justify for fast-moving financial variables, the authors identify the shock with an external instrument in a proxy-SVAR framework (following Stock-Watson 2012, Mertens-Ravn 2013, and Gertler-Karadi 2015): the daily change in the German 10-year government bond yield on ECB Governing Council meeting days, augmented with three special-event days (the May 2010 and August 2011 SMP announcements and Draghi’s July 2012 “whatever it takes” speech). The instrument clears a weak-instrument check (first-stage F = 10.44, above the Stock-Wright-Yogo threshold of 10) and an event-study validation showing it moves the EURIBOR future (beta = 0.890) and corporate bond spreads (beta = 0.192) with the expected sign. In a baseline monthly four-variable VAR (log industrial production, log HICP, a corporate BBB-minus-AA bond spread proxying the external finance premium, and a Wu-Xia shadow short rate, with the oil price entered exogenously to avoid the price puzzle), an expansionary shock normalized to a 25-basis-point drop in the shadow rate significantly raises output and prices and narrows the corporate spread – evidence of a credit channel that disappears under a comparable Cholesky-identified VAR, where the spread does not react significantly. Extending the system one variable at a time shows the real exchange rate depreciates on impact, a house-price proxy (the HICP rent component) rises, and bank lending standards relax while credit demand rises, yet – a “credit puzzle” – total loan volume to nonfinancial corporations actually falls in the post-2008 sample, while unemployment and equity prices move with the expected sign but are statistically insignificant (cannot rule out zero) over the full horizon. Decomposing the instrument via a Jarocinski-Karadi (2018)-style principal-component analysis of announcement-day yield and equity changes (the first two components jointly explain 92% of the variance) into a pure policy shock and a central-bank information shock shows the baseline results are reproduced by the pure policy component, so the findings are robust to stripping out information effects. Feeding the identified aggregate shock into Jordà (2005) local projections for ten member countries (covering more than 95% of euro-area GDP) plus a synthetic euro area reveals substantial cross-country heterogeneity beneath the homogeneous aggregate response: industrial production and consumer prices respond similarly almost everywhere, but unemployment falls significantly only in core countries (Germany, France, the Netherlands) and not in the periphery (Italy, Spain, Greece), stock prices deviate negatively in several countries after about ten months, and loan volumes rise significantly only in Germany, Austria, and Greece. The authors read this as evidence that impaired transmission through bank lending and equity markets – concentrated in periphery countries with stressed banking systems – and labor-market frictions drive the uneven effectiveness of a “one-size-fits-all” ECB policy, while explicitly cautioning that their country-level results are “purely positive” and that “we should be careful not to overemphasize the normative implications.”

Peter Tillmann | Macro Paper Warehouse

The Aggregate and Country-Specific Effectiveness of ECB Policy: Evidence from an External Instruments VAR Approach