Monetary Policy in the Euro Area: Active or Passive?

We estimate a medium-scale DSGE model for the Euro Area allowing and testing for indeterminacy since the introduction of the euro until mid-2023. Our estimates suggest that monetary policy in the euro area was passive, lead- ing to indeterminacy and self-fulfilling dynamics. Indeterminacy dramatically alters the transmission of fundamental shocks, particularly for inflation whose responses are inconsistent with standard economic theory. Inflation increases following a positive supply or a negative demand shock. Consequently, de- mand shocks look like supply shocks and vice versa, making the dynamics of the model under indeterminacy challenging to interpret. However, this find- ing is not robust across different assumptions on the way the sunspot shock is specified in the estimation. Both under determinacy and indeterminacy, the model estimates a natural rate of interest that turned positive after the recent inflation episode.