Publication of the week: Dr Juan Castañeda

José Luis Cendejas, Juan E. Castañeda and Félix-Fernando Muñoz, “Business cycle, interest rate and money in the euro area: A common factor model”, Economic Modelling 43 (Dec 2014), 136–141. doi: 10.1016/j.econmod.2014.08.001

Surprisingly enough money has long been neglected both by academia in the building up of the mainstream macroeconomic models and by central banks in the shaping of monetary policy decisions. This paper analyses the contemporaneous correlation between short term nominal interest rate, monetary aggregates, production and prices in the euro area; but not just CPI prices but also financial assets and real estate prices. As to the monetary aggregates, the authors study the cyclical correlation with the variables mentioned above of both a narrow and a broad definition of money. The main finding of the paper is the estimate of a common cyclical factor for the evolution of interest rates, a broad monetary aggregate production and CPI and asset prices; which is explained by the monetary policy strategy of interest rate pegging followed by the European Central Bank (ECB). The policy implications are significant as well. The shared cyclical information suggests that inflation should be considered as a phenomenon that affects all prices of the economy and that broad monetary aggregates (such as M3 in the euro area) may contribute to the assessment of inflationary risks throughout the cycle and thus should have a more explicit role in the ECB monetary policy strategy.

Read abstract and highlights on the Science Direct website.