No abstract

Financial asset prices contain a rich set of real-time information on the economy. To extract this information, it is crucial to understand the driving factors behind financial market developments. In this paper, we exploit daily cross-asset price movements in a sign-restricted BVAR model to analyse the extent to which euro area and US yields, equity prices, and the euro-US dollar exchange rate are jointly driven by monetary policy, macro and global risk factors. A novelty is that we allow for cross-Atlantic spillovers while also accounting for the unique role of the US in the global financial system. Our results underline the importance of US spillovers and shifts in global risk sentiment for understanding the dynamics of euro area financial variables. Euro area shocks transmit much less to US financial markets in comparison, with global risk shocks being more important instead. Using the daily shocks as instruments in a Proxy-SVAR, we demonstrate that the transmission of financial market movements to the macroeconomy depends on the underlying driver, thereby illustrating why it matters to look into the driving factors in the first place.

This paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB.

The 20th anniversary of Economic and Monetary Union (EMU) offers an opportunity to look back on the record of the European Central Bank (ECB) and learn lessons that can improve the conduct of policy in the future. This volume charts the way the ECB has defined, interpreted, and applied its monetary policy framework—its strategy—over the years from its inception, in search of evidence and lessons that can inform those reflections. Our ‘Tale of Two Decades’ is largely a tale of ‘two regimes’: one—stretching slightly beyond the ECB’s mid-point—marked by decent growth in real incomes and a distribution of shocks to inflation almost universally to the upside; and the second—starting well into the post-Lehman period—characterized by endemic instability and crisis, with the distribution of shocks eventually switching from inflationary to continuously disinflationary. We show how the most defining feature of the ECB’s monetary policy framework, its characteristic definition of price stability with a hard 2 per cent ceiling, functioned as a key shock absorber in the relatively high-inflation years prior to the crisis, but offered a softer defence in the face of the disinflationary forces that hit the euro area in its aftermath. The imperative to halt persistent disinflation in the post-crisis era therefore called for a radical, unprecedented policy response, comprising negative policy rates, enhanced forms of forward guidance, a large asset purchase programme and targeted long-term loans to banks. We study the multidimensional interactions among these four instruments and quantify their impact on inflation and the macroeconomy.

This paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB.