Finance and Economics Discussion Series (FEDS)
September 2025
One Policy Rate, Many Stances: Evidence from the European Monetary Union
Manuel González-Astudillo, Diego Vilán
Abstract:
A challenge for conducting monetary policy in a currency union is the diverse economic conditions among member states. Such disparities can drive natural interest rates apart, thereby undermining the stabilizing role of a unified monetary policy. To assess the stance of monetary policy across Eurozone-19 countries, we estimate their natural rates of interest (r∗) and inflation trends (π∗) to construct a measure of the country-level neutral nominal interest rates (r∗ + π∗) over 1999-2025, using a semistructural model that jointly characterizes the trend and cyclical components of key macroeconomic variables such as output, unemployment, inflation, 10-year government bond yields, and the common policy interest rate. Our setup improves upon those in the existing literature by allowing both a short-run interest rate gap—driven by the (shadow) policy rate—and a long-run interest rate gap—driven by the country-specific 10-year government bond yields—to affect and reflect economic conditions. We also impose cointegration between the dynamics of the country-specific latent variables and common counterparts to incorporate co-movements across the euro area economies. Our results show that the stance of monetary policy is homogeneous across the countries in our sample, but that a relatively highly degree of heterogeneity emerges at key historical turning points.
Keywords: Common monetary policy challenges, Euro area economies, Interest rate gap, Neutral interest rate, Sovereign debt risk.
DOI: https://doi.org/10.17016/FEDS.2025.087
PDF: Full Paper
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