16 November 2020

The Impact of Monetary Policy on the Real Economy

In her recently defended PhD thesis, Anne Kathrin Funk provides three essays in empirical monetary economics that try to improve the understanding of the transmission channels and possible side effects of central banks’ unconventional monetary policies. They also discuss how positive inflation can prevent binding wage rigidities and negative consequences for the real economy.

How did you come to choose your research topic?

I started to study Economics right after the outbreak of the global financial crisis in 2008. In the course of my undergraduate and graduate programmes, central banks worldwide started to face very low inflation, even deflation, as well as financial market disruptions and lowered interest rates tremendously. Right after the start of my PhD at the Graduate Institute in 2014, the European Central Bank (ECB) announced its first quantitative easing programme, the Swiss National Bank removed the minimum exchange rate floor in January 2015 and introduced negative interest rates. Monetary policymakers entered new territory with these tools and in the beginning, it was not clear how these unconventional policies operate and transmit to prices and output. Thereby I got interested in monetary policy and its transmission channels.

Can you describe your research questions and the methodology you use to approach them?

I analyse to what extent firms are not able or willing to cut nominal wages and whether this leads to higher unemployment. Together with Daniel Kaufmann, we compare the labour market outcomes of employees with rigid wages to those with flexible wages after the removal of the Swiss franc floor in 2015, which caused an unexpected deflationary shock. Furthermore, I study the impact of the ECB’s main government bond purchase programme on credit access as well as employment and investment outcomes of small and medium-sized firms, by controlling for credit demand, credit supply and firms’ characteristics.

What are your major findings?

Nominal wage rigidity can be harmful for the economy by causing higher unemployment and lower income. Furthermore, the ECB is successful in improving credit access for small and medium-sized firms by conducting its quantitative easing programme. Thereby, monetary policy is able to affect the real economy by stimulating employment and investment growth. Particularly those firms which need support – small firms in the periphery of the euro area – benefit the most from the programme. 

Can you give an example of a topical issue on which your thesis might help shed a new light?

The Corona crisis triggered a recession in many countries in Europe and poses huge and new challenges for fiscal and monetary policymakers on how to deal with the economic consequences of the pandemic. My thesis shows that monetary policy can help to mitigate the shock by buying government bonds. Quantitative easing can stimulate bank lending and thereby affect firms’ employment and investment growth. In the past, this mechanism was particularly effective in countries like Italy or Spain – the countries strongest hit by the pandemic.

How can your research findings serve society?

The findings of my thesis show that it is paramount that central banks meet their inflation targets, and that price stability is an important ingredient for the functioning of the economy. A deflationary environment can cause higher unemployment, because firms are reluctant to lower wages. Furthermore, central banks are able to achieve their mandate of price stability by using unconventional monetary policy tools, such as quantitative easing. The German Constitutional Court has argued that the ECB exceeds its mandate by buying government bonds. However, my thesis shows that the ECB is improving lending conditions for small firms and improves employment possibilities of citizens. Nonetheless, I do not analyse which side effects a quantitative easing programme has and whether it leads to higher risk taking by increasing lending to more risky borrowers.

What are you doing now?

I am currently working as a Research Analyst in the Monetary Policy Strategy Division of the European Central Bank. Together with my colleagues, we prepare the monetary policy decisions of the ECB’s Governing Council. 

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More on Dr Funk’s PhD thesis 

Anne Kathrin Funk defended “Essays in Empirical Monetary Economics” in September 2020. Professor Beatrice Weder Di Mauro presided the committee, which included Professor Cédric Tille and Professor Jan-Egbert Sturm, thesis co-supervisors, and Mr Luca Dedola, Adviser, Monetary Policy Research Division, European Central Bank, Germany,

In the past decade, central banks worldwide started to face new challenges: Rather than preventing too high inflation rates, monetary policymakers started to worry about too low inflation. Very low and even negative policy rates and large balance sheet expansion together with unconventional monetary policies were necessary to achieve price stability. The thesis addresses these new challenges by analysing how wage rigidity affects the real economy in a deflationary environment. Base wages in Switzerland exhibit a substantial degree of rigidity, which has negative consequences on income and employment – despite a comparably flexible labour market. It further investigates the impact of the ECB’s Public Sector Purchase Programme (PSPP) on bank lending and to employment and investment outcomes of small companies. The PSPP improved credit access of small firms and positively affected the real economy. Especially firms in the periphery of the euro area benefitted from the PSPP. The final chapter focuses on the interplay of low interest rates and the Swiss housing market, how it changed over time and region. Most of house price variation can be explained by fundamentals such as demand and supply for housing or GDP growth. Apartment prices got more sensitive to mortgage rate changes during the recent house price boom and there is substantial heterogeneity across Swiss regions. The thesis contributes to the understanding of the transmission channels and possible side effects of central banks’ unconventional monetary policies and discusses how higher inflation targets can prevent binding wage rigidities and negative consequences for the real economy.  

Full citation
Funk, Anne Kathrin. “Essays in Empirical Monetary Economics.” PhD thesis, Graduate Institute of International and Development Studies, Geneva, 2020.

Good to know

  • Members of the Graduate Institute can access Dr Funk’s PhD thesis via this page of the Institute’s repository.
  • Her essay “Do Sticky Wages Matter? New Evidence from Matched Firm-Survey and Register Data”, co-authored with Daniel Kaufmann, is also available as an International Economics Department Working Paper on this page of the repository.
  • Her essay “Quantitative Easing in the Euro Area and SMEs’ Access to Finance: Who Benefits the Most?” is also available here (PDF).
  • Her essay “Time-Varying and Regional Dynamics in Swiss Housing Markets”, co-authored with Dirk Drechsel, was also published in the Swiss Journal of Economics and Statistics,

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Interview by Nathalie Tanner, Research Office.
Banner picture: excerpt from an image by moritz320 on Pixabay.