Cross-country Elasticity of Intertemporal Substitution and Common Monetary Policy in the Eurozone: A Study of Consumption Choice Heterogeneities in Response to Changes in the Interest Rate set by the ECB

Anna Ingemann & Martina Facino

Student thesis: Master thesis

Abstract

In analysing the effectiveness of monetary policy, it is important to understand to what extent and why there may exist differences in how sensitive consumers’ intertemporal consumption choice is to changes in the monetary policy rate. This paper estimates the elasticity of intertemporal substitution (EIS) across the eurozone and uses the results to discuss the effectiveness of the eurozone from a monetary policy perspective. We find evidence of EIS heterogeneity in the sense that consumers around Europe differ greatly in willingness to rearrange their intertemporal consumption choice given a change in the short-term interest rate. These differences are structural and relate to differences in wealth, asset market participation and credit availability, as well as cultural differences. This suggests that common monetary policy as set by the ECB will have a dissimilar impact around the eurozone. In light of this finding, combined with a discussion on fiscal transfer programmes and initiatives to direct member countries towards more fiscal prudence, we discuss the effectiveness of the eurozone. We argue that while the eurozone is not an optimum currency area and EIS heterogeneity reduces monetary policy effectiveness, the individual member country is better served with staying within the eurozone.

EducationsMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
LanguageOther
Publication date2017
Number of pages260