Too small to be independent? On the influence of ECB monetary policy on interest rates of the EEA countries

Monetary policy independence is regarded as the central argument in favour of floating exchange rates and monetary integration. We evaluate the actual independence of non-euro members of the European Economic Area by using heterogeneous panel cointegration methods that allow cross-dependency. We show that domestic interest rates follow the euro interest rates. These spillovers imply a low monetary independence despite the insulation given by floating exchange rate regimes and inflation-targeting frameworks. We therefore find significant spillover effects of the European Central Bank policy and argue that the costs of monetary integration in Europe may be lower than expected.     

Forecasting the Direction of Policy Rate Changes: The Importance of ECB Words

This paper evaluates the predictive power of different information sets for the European Central Bank (ECB) interest-rate-setting behaviour. We employ an ordered probit model, i.e. a limited dependent variable framework, to take into account the discreteness displayed by policy rate changes. The results show that the forecasting ability of standard Taylor-type variables, such as inflation and output gap, is fairly low both in-sample and out-of-sample, and is comparable to the performance of the random walk model. Instead by using broader information sets that include measures of core inflation, exchange rates, monetary aggregates and financial conditions, the accuracy of the forecasts about ECB future actions substantially improves. Moreover, ECB rhetoric considerably contributes to a better understanding of its policy reaction function. Finally, we find that that the ECB has been fairly successful in educating the public to anticipate the overall future direction of its monetary policy, but has been less successful in signalling the exact timing of rate changes.     

Estimating the ECB Policy Reaction Function

Abstract. This paper estimates the policy reaction function of the European Central Bank in the first four years of EMU using an ordered probit model which accounts for the fact that central bank rates are set at multiples of 25 basis points. Starting from a baseline model which mimics the Taylor rule, the impacts of different economic variables on interest rate decisions are analysed. It is concluded that the monetary growth measure which was announced by the ECB as the first pillar of their monetary strategy does not play an outstanding role for the actual interest rate decisions. More sophisticated measures like the money overhang which uses information from both pillars are better suited. Overall, it is concluded that the revision of the monetary policy strategy in May 2003 which implied a downgrading of the first pillar will not induce any observable changes in monetary policy decisions.     

Unique monetary equilibria with interest rate rules: An extension

In a recent paper, Adão et al. (2011), using a cash-in-advance framework, derive an interest rate rule that results in a unique monetary equilibrium. The resulting interest rate rule is forward looking and the interest rate responds positively to forecasts of future real activity and to forecasts of the future price level. This paper extends their approach to a transactions cost environment. The resulting interest rate rule has the added feature that, in line with previous studies, the nominal interest rate responds positively to forecasts of future inflation.     

The effect of ECB monetary policies on interest rates and volumes

This article assesses the transmission of ECB monetary policies, conventional and unconventional, to both interest rates and lending volumes or bond issuance for three types of different economic agents through five different markets: sovereign bonds at 6-month, 5-year and 10-year horizons, loans to nonfinancial corporations and housing loans to households, during the financial crisis, and for the four largest economies of the euro area. We look at three different unconventional tools: excess liquidity, longer-term refinancing operations and securities held for monetary policy purposes following the decomposition of the ECB’s Weekly Financial Statements. We first identify series of ECB policy shocks at the euro area aggregate level by removing the systematic component of each series and controlling for announcement effects. We second include these exogenous shocks in country-specific structural VAR, in which we control for credit demand. The main result is that only the pass-through from the ECB rate to interest rates has been effective. Unconventional policies have had uneven effects and primarily on interest rates.     

Time-varying inflation persistence in the Euro area

This paper investigates how inflation persistence in the Euro area has evolved between 1991 and 2006. Employing an ARMA(1,11) model with time-varying autoregressive parameter, we find that inflation persistence has fallen markedly since the third stage of the EMU began in January 1999 and inflation no longer exhibits unit-root behaviour.     

Lessons from the ECB Experience: Frankfurt Still Matters!

This paper compares the European Central Bank's (ECB) conduct of monetary policy (1999–2005) with that of the Bundesbank (after the German Unification: 1990–1998) in order to test the hypothesis of an ECB with 'Bundesbank's preferences' put forward in the theoretical literature ( Alesina and Grilli, 1993 ; Fatum, 2006 ). Econometric tests and simulations based on monetary policy reaction functions show that the continuation of the former Bundesbank regime is supported by the data. Given this empirical evidence we discuss the lessons for future Monetary Unions stemming from the ECB experience.     

ECB repo rate setting during the financial crisis

I estimate a reaction function for the ECB using an ordered logit model for the period 1999-2009. Allowing for a smooth transition from one set of parameters to another, I detect a rapid change in the middle of 2008.     

How the ECB and the US Fed set interest rates

Monetary policies of the European Central Bank (ECB) and US Fed can be characterized by ‘Taylor rules’, that is both central banks seem to be setting rates by taking into account the ‘output gap’ and inflation. We also set up and tested Taylor rules which incorporate money growth and the euro–dollar exchange rate, thereby improving the ‘fit’ between actual and Taylor rule based rates. In general, Taylor rules appear to be a much better way of describing Fed policy than ECB policy. Simulations suggest that the ECB's short-term interest rates have been at a much lower level in the last 2 years compared with what a Taylor rule would suggest.     

Forecasting ECB monetary policy: Accuracy is a matter of geography

Monetary policy in the euro area is conducted within a multi-country, multi-cultural, and multi-lingual context. How does this heterogeneity affect the ability of economic agents to understand and to anticipate monetary policy by the European Central Bank (ECB)? Using a database of surveys of professional ECB policy forecasters in 24 countries, we find remarkable differences in forecast accuracy, and show that these have important repercussions on market behaviour. Explaining the differences in forecast accuracy, we provide evidence that they are partly related to geography and clustering around informational hubs, as well as to country-specific economic conditions. In large part this heterogeneity can be traced to differences in forecasting models.     

Household lending, interest rates and housing price bubbles in Korea: Regime switching model and Kalman filter approach

This study investigates whether interest rates and household lending caused housing price bubbles in Korea over the period of 1986 to 2003. Using a regime-switching model, we found evidence of the existence of housing price bubbles throughout the sample period, with the exception of 1998 when Korea suffered from a financial crisis. Using a Kalman filter technique, we estimated the size of housing price bubbles for the sample period. Finally, using generalized impulse response function analysis and variance decompositions, we found that housing price bubbles increased with household lending and industrial production, whereas they decreased with interest rate; this latter effect is relatively small, however. Policy implications include the importance of preemptive intervention on household lending in order to contain housing price bubbles, but interest rates appear to be a less effective policy tool.     

Taylor rules in the open economy

Taylor rules, which link short-term interest rates to fluctuations in inflation and output, have been shown to be a good guide (both positively and normatively) to the conduct of monetary policy. As a result they have been used extensively to model policy in the context of both closed and open economy models. Their determinacy properties have also been analysed in the context of closed and, to a more limited degree, in small open economy models. In this paper, we extend the analysis of the determinacy properties of Taylor rules to the case of a benchmark two-country model. When the rules are specified in terms of output-price inflation we confirm and extend the conventional results from the closed economy literature—satisfying the Taylor principle is the key to ensuring determinacy, although the presence of backward-looking price-setting can affect the determinacy properties of the two-country model. However, the conventional results do not hold when we replace output-price inflation with consumer price inflation in the specification of the rule. In this case, Taylor rules which satisfy the Taylor principle will be indeterminate, unless there is an unusually large home bias in consumption. Similar indeterminacy problems arise when one country targets CPI inflation and the other output-price inflation. In this case we show that, even if determinacy is achieved, large spillovers may occur between countries.     

The determinants of China's lending rates and interest rates pass-through: A cointegration analysis

Based on quarterly data between Q4, 2008–Q4, 2017, this study examines the interest rates pass-through from policy rate to lending rates, and more broadly, the determinants of lending rates in China. The results show that while there is a certain level of pass-through from money market rates to lending rates, and the interest rates pass-through has improved after the interest rate liberalization completion on October 2015, this pass-through is also negatively affected by the asset quality of commercial banks and shadow banking activities as well. This study also finds that the macroeconomic condition also affects the lending rates.     

Market‐Based Measures of Monetary Policy Expectations and Their Evolution Since the Introduction of the Euro

The paper considers the relation between monetary policy expectations and financial markets in the case of Europe. A number of money market instruments are compared, with the result that the 1‐month forward interest rates extracted from the Libor yield curve has the best prediction power of the future monetary policy path. These forward rates have been used to study the evolution of market expectations regarding the monetary policy of the European Central Bank (ECB). The sharp increases and the following decreases in interest rates during 2000–2001 have reduced the predictive power of money market instruments, but smoother management of interest rates and better communication from the ECB has helped to improve the forecasting power of money market instruments.     

An empirical note on Euro market interest rates,domestic interest rates and the expectations theory of the term structure

An empirical analysis of recent monthly data for 8 currencies indicates that the performance of the expectations theory to explain the short term maturity spectrum of Euro interest rates is rather good in most cases and that it is not related to the degree of integration of Euro and domestic markets.     

Optimal monetary policy: distribution efficiency versus production efficiency

This paper investigates the trade‐off between distribution effect and production effect of monetary policy when there exist unobservable idiosyncratic liquidity shocks. In the absence of risk‐sharing arrangements such as a credit market, monetary policy serves to provide ex post insurance to smooth consumption. Specifically, issuing interest‐bearing bonds restores credit transactions on money through bond‐money exchanges. Such a policy has a positive distribution effect, but the resulting inflation hampers production efficiency. It is demonstrated that the trade‐off between distribution efficiency gain and production efficiency loss would result in net welfare enhancement if consumers are relative‐risk‐averse enough.     

Structural breaks in the lending interest rate pass-through and the euro

This paper investigates whether size and speed of the pass-through of market rates into short term business lending rates have increased in the wake of the introduction of the euro. Allowing for multiple unknown structural breaks we find two in four EMU countries, and in the UK as well, and a single one in five other countries. The pattern of dates fits national banking systems adjusting slowly to the new monetary regime and suggests caution in associating structural changes to the introduction of the euro. The estimated equilibrium pass-through in the last break-free period is on average more incomplete, hinting at a reduced effectiveness of the single monetary policy. These results run against the economic intuition that a reduced volatility in money market rates is bound to mitigate uncertainty and to ease therefore the transfer of policy rate changes to retail rates; the run-up to Basel 2 and a deterioration of competition in loan markets could be the motivations. Caution in extrapolating these findings to recent periods is suggested by the differences between the unharmonized and the new harmonized retail rates.     

Investment and interest rate policy: a discrete time analysis

This paper analyzes the restrictions necessary to ensure that the interest rate policy rule used by the central bank does not introduce local real indeterminacy into the economy. It conducts the analysis in a Calvo-style sticky price model. A key innovation is to add investment spending to the analysis. In this environment, local real indeterminacy is much more likely. In particular, all forward-looking interest rate rules are subject to real indeterminacy.     

Measuring the impact of monetary policy on asset prices in Turkey

Little is known about the impact of monetary policy on asset prices in emerging markets. This study applies the heteroscedasticity-based GMM for financial markets in Turkey. The results suggest that event study estimates are biased for some asset returns.     

Equilibrium real interest rates and the financial cycle: Empirical evidence for Euro area member countries

We estimate the equilibrium real interest rate for nine Euro area member countries and the Euro area as a whole using quarterly data from 1995 to 2015. We expand the standard model of estimating real equilibrium interest rates to incorporate the financial cycle for the private sector. We show that adding the financial cycle indeed alters the equilibrium real interest rate estimates and, in line with previous studies, that there is a fall in the equilibrium real interest rate over time. Our results indicate that in most member countries the real rate is lower than its equilibrium level. Hence, they should not worry about secular stagnation now. This is because secular stagnation is likely to occur when real interest rates are higher than their equilibrium levels. This result can serve as a starting point for further research in this field, e.g. by adding public sector financial cycles or disentangling the roles of households, corporations and the government.