Scandinavian Working Papers in Economics

Ratio Working Papers,
The Ratio Institute

No 287: The Cost Channel Effect of Monetary Transmission: How Effective is the ECB's Low Interest Rate Policy for Increasing Inflation?

Dorothea Schäfer (), Andreas Stephan () and Khanh Trung Hoang
Additional contact information
Dorothea Schäfer: DIW Berlin, JIBS and CERBE, Postal: DIW Berlin, Mohrenstr. 58, 10117 Berlin
Andreas Stephan: Linnæus University, Ratio Institute and JIBS, Postal: The Ratio Institute, P.O. Box 5095, SE-102 42 Stockholm, Sweden
Khanh Trung Hoang: DIW Berlinn, Postal: DIW Berlin, Mohrenstr. 58, 10117 Berlin

Abstract: We examine whether monetary transmission during the financial and sovereign debt crisis was dominated by the cost channel or by the demand-side channel effect. We use two approaches to track down the potential passthrough of changes in the monetary policy rate to those in consumer prices. First, we utilize panel data from the German manufacturing industry. Second, we conduct time series analyses for Germany, Italy, and Spain. We find that when manufacturing firms’ interest costs drop, the changes in their respective industry’s price index are smaller one year later. This finding is consistent with the cost channel theory. Taken together, the results of both panel data and time series analyses imply that the ECB’s low interest rate policy has worked better for boosting inflation in Italy and Spain than in Germany.

Keywords: Inflation; cost channel; monetary transmission

JEL-codes: E31; E43; E43; G01; G01

39 pages, March 23, 2017

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