Research Discussion Papers, Bank of Finland
No 27/1998:
The Exchange Rate and Monetary Conditions in the Euro Area
David G. Mayes ()
and Matti Viren ()
Abstract: Using information from a variety of sources, including our
own estimates from quarterly data for each of the countries over the period
1972–1997, this paper suggests that the exchange rate will play an
important role in the transmission of the impact of monetary policy through
to the real economy and inflation in the euro area. Although the share of
external trade in the euro area's GDP is only around 10 per cent this is
only one factor that affects the transmission mechanism and the role of the
exchange rate is likely to be substantially greater when all factors are
taken into account. As a first approximation it would be reasonable to
assume that an increase in the real 90-day interest rate of 100 basis
points would have approximately the same effect on demand pressure two
years later as a 3.5 per cent fall in the real euro exchange rate. This
implies that the euro area will tend to behave like a large open economy
rather than a closed economy and hence that it would be helpful in
informing monetary policy to construct a Monetary Conditions Index (MCI)
using these weights. A separate paper (Mayes and Virén, 1998) suggests how
an MCI provides a useful summary of high frequency information to assist
monetary policy and financial markets in short run decisions.
Keywords: monetary conditions index; exchange rate; monetary policy; euro area; (follow links to similar papers)
26 pages, December 11, 1998
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