The economic consequences of Euro-area macro-modelling shortcuts

Abstract

Should euro-area economies be modelled in an aggregate (area-wide) fashion or in a disaggregate (multi-country) one? This paper tackles that question from both a statistical and an economic viewpoint. From a statistical viewpoint, aggregation bias criteria are found to signal that the degree of structural heterogeneity among euro-area economies is such that the loss of information entailed by an aggregate modelling approach may be far from trifling. From an economic viewpoint, we investigate the following issue: Are those statistically detectable heterogeneities of any practical relevance when it comes to supporting monetary policy decision-making? To provide an answer to this question, we compute simple optimal monetary policy reaction functions on the basis of either an aggregate model or a disaggregate one, and compare the associated welfare losses. The results suggest that the welfare under-performance of an area-wide-model-based rule is not only non negligible, but also robust with respect to a number of sensitivity analyses.