A Small Dynamic Hybrid Model for the Euro Area

The authors estimate and solve a small structural model for the euro area over the 1983–2000 period. Given the assumption of rational expectations, the model implies a set of orthogonality conditions that provide the basis for estimating the model’s parameter by generalized method of moments. The authors’ main results are: (i) the impulse-response functions implied by the model are consistent with the standard stylized facts about the dynamic effects of monetary policy, (ii) evidence suggests that flexibility in Europe has increased since the adoption of the Maastricht Treaty, and (iii) the inflation expectations captured by the model might explain the European Central Bank’s reluctance to ease monetary conditions in 2000.