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The first simulation we consider is a permanent monetary expansion in the United States. In
this scenario the money target for the US is shocked permanently by 1 per cent. It is assumed
that the US monetary authorities apply a regime of strict money targeting and that the target
is met instantaneously. On the other hand, for all other countries we assume that monetary
policy is accommodating and the authorities target their nominal interest rates. This
effectively means that exchange rates within Europe remain fixed.
Table 7 shows the results of this simulation for the US. Under these assumptions a monetary
expansion raises output in the short run, but this boost is short-lived. In the first year GDP
grows by 0.5 per cent 7, but this effect ebbs away quickly in the following years. Prices rise
instantaneously and within 3 years they have risen by three quarters of a per cent. In the long
run the monetary expansion is fully reflected in proportionally higher prices and there is no
long run effect on real variables. This simulation is of course run under an extreme
assumption of tight money targeting to illustrate the transmission mechanisms of the model.
For policy analysis, a more realistic scenario would assume looser targeting of the money
supply by the central bank and that would obviously reduce the speed of adjustment.
The international transmission effects of a monetary expansion in one country is theoretically
ambiguous. On the one hand, the monetary expansion in the US lowers real interest rates and
raises US demand for European exports. On the other hand, it leads to an appreciation of the
European currencies which boosts their imports and shifts demand away towards the US. As
can be seen in Table 7.a, which summarises the international transmission effects on the other
countries, these two effects more or less cancel each other out and the spillover effects are
small. For countries like Germany and Sweden the increase in world demand dominates and
output rises, while for the smaller open economies like the Netherlands, Belgium and Ireland,
the negative effects of the appreciation dominate and demand is shifted away abroad. On the
whole, though, the net effects on GDP are small for all countries.
Table 8 summarises the results of a permanent monetary expansion of 1 per cent in the EU
countries (detailed tables in the annex). Exchange rates are flexible and monetary targeting is
assumed to be strict. Under these assumptions, output rises in the EU by on average 0.6 per
cent in the first year. The monetary expansion is reflected in an immediate depreciation of
the exchange rate and a rise in prices. In real terms the depreciation is much smaller though
and in the medium term competitiveness is fully restored. After three years prices have risen
by at least three quarters of a percent while the exchange rate has depreciated by one percent.
The gains from a monetary expansion are short-lived and in the long run money is neutral in
the model.
7 This impact multiplier is consistent with the findings of Blanchard (1989) who finds that the short run
effect of a monetary expansion on output in a VAR system with keynesian features is roughly of that
order of magnitude.
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