5 February 2025
The monetary policies of the ECB and the US Federal Reserve are not always in sync. But how does the Fed’s policy affect the euro area economy? This ECB Blog looks at how monetary policy in the United States travels across the Atlantic and what this means for the ECB.
The global economy is interconnected. Central banks’ monetary policies therefore often affect other economies. These “monetary policy spillovers” are particularly relevant for economies as closely linked as the United States and the euro area. Spillovers from US monetary policy initially work in the opposite direction to ECB monetary policy, but then later in the same direction. For instance, a surprise tightening of US policy leads to an initial increase in euro area inflation as the euro weakens. However, over time, tighter US monetary policy drags down euro area inflation much like tighter ECB policy would.
In more detail, when the Fed unexpectedly raises interest rates to curb inflation and economic activity, euro area inflation increases on average over the three months following the announcement. This is because, following a surprise tightening in the United States, the euro immediately weakens against the dollar. And that makes imported goods more expensive. This effect is particularly relevant for euro area imports priced in US dollars, such as oil and other commodities. The weaker euro also cheapens euro area exports to the United States. This, in turn, supports economic activity and prices in the euro area slightly. Hence, over the short run, the spillovers from a surprise US monetary policy tightening on the euro area economy work in the opposite direction to the effects of a monetary policy tightening by the ECB. This is visible in the left-hand parts of each subplot of Chart 1.
Over time, however, the initial inflationary impact of higher policy rates in the US is compensated by broader disinflationary pressures. Tighter US financing conditions spill over to the euro area through global financial markets, leading to a slowdown in euro area economic activity. At the same time, the Fed’s tightening also weighs on economic activity in the US over time, with lower demand by US households and firms also implying lower imports from the euro area. Overall, the medium-term effects of US monetary policy on the euro area therefore resemble the dampening impact of similar actions by the ECB. This means that – while the immediate impacts might differ – in the medium term US monetary policy pushes the euro area economy in the same direction as euro area policy changes would. These effects can be seen for the same variables on the right-hand parts of each subplot in Chart 1.
Chart 1
Impact of euro area (EA) and US monetary policy shocks on the euro area economy
Source: ECB staff calculations.
Notes: Impulse responses (IR) for selected horizons, scaled to 25 bps reaction in the 3-months OIS rate and the 3-months US Treasury bill rate, respectively, derived by local projections (Jorda (2005)). ECB and Fed monetary policy shocks are identified via high-frequency movements in short-term market rates over a narrow window (ca. 135 minutes) around ECB and Fed policy meetings applying “poor man’s” sign restrictions as in Jarocinski and Karadi (2020). Euro area shocks are extracted from the policy-event database of Altavilla et al. (2019). The euro area outcome variables are: (i) the Harmonised Index of Consumer Prices (left panel), (ii) industrial production (right panel). All variables are in log-levels. The local projections control for the lagged dependent variables, the Euro-Dollar exchange rate, euro area exports to and euro area imports from the US, the euro area unemployment rate, log-levels of US industrial production and the US Consumer Price Index, the euro area Composite Indicator of Systemic Stress (CISS), the IMF Commodities Price Index, the GDP-weighted 10-year yields on euro area sovereign bonds, the euro area 3-months OIS rate, and the other jurisdiction’s monetary policy shocks. Moreover, forward dummies for the COVID-19 pandemic (from March 2020 to April 2023) and the war in Ukraine (from March 2022 onwards) enter the model at the same horizon as the dependent variables. All data are at monthly frequency for the 2002m1-2024m5 period. Standard errors are derived from the Newey and West (1987) estimator to account for autocorrelation and heteroskedasticity. Results are comparable to estimates presented in Ca’ Zorzi et al. (2023). Additional details are available in Gebauer et al. (2025).
How did we come up with these findings?
We used an empirical method called local projections to analyse the impact of US monetary policy surprises, or “shocks”, on the euro area. Shocks correspond to the change in monetary policy that goes beyond the regular response of a central bank to economic developments. Studying such shocks provides clearer insights into the cause-and-effect relationships of policy with subsequent economic developments. The monetary policy shocks are derived by measuring financial market movements in a tight time window around monetary policy decisions on either side of the Atlantic. Having isolated the shocks, we integrated them into a local projections model that – based on historical regularities – tells us how economic variables, such as euro area inflation and industrial production, respond to US and euro area monetary policy shocks over time. This approach helps distinguish between short-term and medium-term effects and thus provides a nuanced understanding of how policy impacts unfold.
And why is it important?
Our findings have important implications for the conduct of the ECB’s monetary policy in the presence US monetary policy spillovers. Simply mimicking a surprise move in US policy rates might avert short-term spillovers, such as higher (or lower) inflation. Over the medium term, however, this would add to the tightening (or easing) impulse from abroad which, all else equal, would create risks that the ECB in turn undershoots (or overshoots) its domestic inflation target. Accounting for such medium-term spillovers is important because of the explicit medium-term orientation embedded in the ECB’s inflation target.
The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.
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References
Altavilla, C., Brugnolini, L., Gürkaynak, R. S., Motto, R., and Ragusa, G. (2019). Measuring euro area monetary policy. Journal of Monetary Economics, 108:162–179.
Ca’ Zorzi, M., Dedola, L., Georgiadis, G., Jarocinski, M., Stracca, L., and Strasser, G. (2023). Making waves: Monetary policy and its asymmetric spillovers in a
globalised world. International Journal of Central Banking, 19(2):95–144.
Gebauer, S., Georgiadis, G., Holm-Hadulla, F., and Kostka, T. (2025). Macroeconomic effects of (de-) synchronized monetary policy shocks. mimeo.
Georgiadis, G. and Jarocinski, M. (2023). Global spillovers from multi-dimensional us monetary policy. ECB Working Paper Series, 2881.
Jarocinski, M. and Karadi, P. (2020). Deconstructing monetary policy surprises—the role of information shocks. American Economic Journal: Macroeconomics, 12(2):1–43.
Jorda, O. (2005). Estimation and inference of impulse responses by local projections. American Economic Review, 95(1):161–182.
Newey, W. K. and West, K. D. (1987). A simple, positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica, 55:703– 708.