The ECB's Time-Varying Policy Trade-Off

We study how the policy trade-off between the unemployment rate and inflation has changed over time in the euro area using a factor-augmented VAR with time-varying parameters and stochastic volatility. Our findings suggest that the trade-off was relatively stable during earlier periods but improved substantially between 2010 and 2015. Based on counterfactual analyses, we conclude that this improvement was mainly the result of unconventional policy shock that were transmitted through a more powerful exchange rate channel. Finally, the time-variation in the policy trade-off is primarily evident for core countries, while periphery countries exhibit a rather stable trade-off throughout the sample.