Whose inflation rates matter most? A DSGE model and machine learning approach to monetary policy in the Euro area

  • In the euro area, monetary policy is conducted by a single central bank for 20 member countries. However, countries are heterogeneous in their economic development, including their inflation rates. This paper combines a New Keynesian model and a neural network to assess whether the European Central Bank (ECB) conducted monetary policy between 2002 and 2022 according to the weighted average of the inflation rates within the European Monetary Union (EMU) or reacted more strongly to the inflation rate developments of certain EMU countries. The New Keynesian model first generates data which is used to train and evaluate several machine learning algorithms. They authors find that a neural network performs best out-of-sample. They use this algorithm to generally classify historical EMU data, and to determine the exact weight on the inflation rate of EMU members in each quarter of the past two decades. Their findings suggest disproportional emphasis of the ECB on the inflation rates of EMU members that exhibited high inflation rate volatility for the vast majority of the time frame considered (80%), with a median inflation weight of 67% on these countries. They show that these results stem from a tendency of the ECB to react more strongly to countries whose inflation rates exhibit greater deviations from their long-term trend.

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Author:Daniel StempelORCiDGND, Johannes ZahnerORCiDGND
URN:urn:nbn:de:hebis:30:3-712050
URL:https://www.imfs-frankfurt.de/forschung/imfs-working-papers/details.html?tx_mmpublications_publicationsdetail%5Bcontroller%5D=Publication&tx_mmpublications_publicationsdetail%5Bpublication%5D=445&cHash=e516fd1877d5b9b0add2a2da0eda6598
Series (Serial Number):Working paper series / Institute for Monetary and Financial Stability (188)
Publisher:Johann Wolfgang Goethe-Univ., Inst. for Monetary and Financial Stability
Place of publication:Frankfurt am Main
Document Type:Working Paper
Language:English
Year of Completion:2023
Year of first Publication:2023
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2023/07/31
Tag:European Monetary Union; Monetary Policy; Neural Networks; New Keynesian Models; Transfer Learning
Edition:This version: May 31, 2023
Page Number:45
HeBIS-PPN:510588077
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / Institute for Monetary and Financial Stability (IMFS)
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Wissenschaftliche Zentren und koordinierte Programme / Sustainable Architecture for Finance in Europe (SAFE)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
JEL-Classification:C Mathematical and Quantitative Methods / C4 Econometric and Statistical Methods: Special Topics / C45 Neural Networks and Related Topics
C Mathematical and Quantitative Methods / C5 Econometric Modeling / C53 Forecasting and Other Model Applications
E Macroeconomics and Monetary Economics / E5 Monetary Policy, Central Banking, and the Supply of Money and Credit / E58 Central Banks and Their Policies
Sammlungen:Universit├Ątspublikationen
Licence (German):License LogoDeutsches Urheberrecht