The federal funds rate and the conduction of the international orchestra

In the first thirteen years of EMU, monetary policy choices of the European Central Bank (ECB) in setting the short-term interest rate have followed, systematically, monetary policy decisions made by the Federal Reserve System (Fed). For, despite the presence of variable lags with respect to Fed decisions, turning points of European short-term interest rates have been largely anticipated by movements in the federal funds rate. In this paper we show that, in the context of a bivariate cointegrated system, a clear long-run US dominance emerges. Moreover, the structural analysis reveals that a permanent increase in the federal funds rate causes a permanent one-for-one movement in the eonia rate.