The Macroeconomic Effectiveness of Unconventional Monetary Policy in the Euro Area: A Structural VAR Analysis

Abstract

Ever since the Global Financial Crisis unfolded in the euro area and a near-zero lower bound was reached, the way in which the ECB conducts monetary policy has radically changed. We investigate the macroeconomic effects of unconventional monetary policy in the euro area using a structural vector autoregression (VAR) with two different identification approaches. The aims of this paper are threefold. First, and most importantly, we show that it is possible to orthogonalize structural shocks in the euro area using identification through heteroskedasticity based on the framework provided by Brunnermeier, Palia, Sastry and Sims (2019) for the US economy. This method identifies the structural shocks on the premise that their variance changes across different time periods and thereby does not require the imposition of any strict short- or long-run restrictions on the structural VAR’s coefficients. Nonetheless, we are able to interpret one of our emerging shocks as a contractionary monetary policy shock whose characteristics are largely consistent with the previous literature. A rise in our policy tool, the shadow short rate, leads to a significant decline in output and a smaller, and less significant, decline in prices. Additionally, we find that the shadow short rate appears to be endogenously driven by financial stress, aggregate demand and aggregate supply shocks. Next, we employ the standard identification approach in the literature, namely a combination of sign and zero restrictions, to confirm our previous results and shed some new light onto the cross-period heterogeneity of unconventional monetary policy effectiveness. While we find that the ECB’s unconventional monetary policy has positively affected the real economy throughout the full time period from 2008 to 2019, our more nuanced analysis shows that it has reaped larger benefits during non-crisis times since 2013. Instead, during crisis times, it has been more effective in reducing financial stress without generating the desired spillover into the real economy. Overall, our findings have important implications for the policy debates surrounding the ECB’s controversial unconventional monetary policy measures, while also contributing an alternative identification framework that can be applied to future eurozone macro studies.