FR-BDF model update: French tightening cuts GDP 2 pp, inflation 1.2 pp
The Banque de France has updated its core macroeconomic model, FR-BDF, to reflect recent economic shifts. The re-estimated model assesses that recent monetary policy tightening will reduce French GDP growth by 2 percentage points and VA inflation by 1.2 percentage points.
New FR-BDF: Steeper curves, amplified transmission
The updated and re-estimated FR-BDF model incorporates significant statistical and structural shifts, including INSEE's transition to a 2020 base year and the volatility observed during the COVID-19 pandemic.
Key new features include a lower capital share, a weaker underlying productivity trend, a steeper price Phillips curve, and a flatter wage Phillips curve.
The model also adds a credit block and an enhanced consumption equation that better captures short-run income effects.
These revisions lead to stronger and faster real effects of monetary policy, with larger GDP and unemployment responses.
This amplification occurs primarily through enhanced transmission via long-term rates and the exchange rate, while nominal responses are more muted.
The comprehensive update ensures the model remains a reliable framework for quarterly projections and policy scenario analysis for the French economy.
Expectations: The critical variable
The updated FR-BDF model assesses the macroeconomic effects of recent monetary policy tightening.
The study highlights that the impact's magnitude and timing depend strongly on how expectations are formed.
Under backward-looking expectations, VA inflation falls by 0.6 percentage points and GDP growth by 1 percentage point at its trough.
Forward-looking expectations show responses nearly three times larger and more front-loaded.
The more realistic hybrid expectations mode, combining forward-looking financial markets with gradual adjustments by other agents, estimates a reduction in VA inflation of about 1.2 percentage points and GDP growth of roughly 2 percentage points at the trough.
These results align with existing literature.
Clarity for policy, caution for forecasts
This model update provides the Banque de France with a more refined tool for understanding the French economy's response to monetary policy.
The findings underscore the critical role of expectation formation in policy transmission, particularly highlighting amplified effects under realistic hybrid scenarios.
For policymakers, this suggests communication strategies influencing expectations are as crucial as the policy decisions themselves.