The Cost Channel Effect of Monetary Transmission: How Effective Is the ECB's Low Interest Rate Policy for Increasing Inflation?

40 Pages Posted: 4 Apr 2017

See all articles by Dorothea Schaefer

Dorothea Schaefer

German Institute for Economic Research (DIW Berlin); JIBS

Andreas Stephan

Jonkoping University, Jonkoping International Business School

Khanh Truong Hoang

German Institute for Economic Research (DIW Berlin)

Date Written: March 29, 2017

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 pass through 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 Classification: G01, E31

Suggested Citation

Schaefer, Dorothea and Stephan, Andreas and Hoang, Khanh Truong, The Cost Channel Effect of Monetary Transmission: How Effective Is the ECB's Low Interest Rate Policy for Increasing Inflation? (March 29, 2017). DIW Berlin Discussion Paper No. 1654, Available at SSRN: https://ssrn.com/abstract=2945264 or http://dx.doi.org/10.2139/ssrn.2945264

Dorothea Schaefer (Contact Author)

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstraße 58
Berlin, 10117
Germany
+49 30 8978 9162 (Phone)
+49 30 8978 9104 (Fax)

JIBS ( email )

Jönköping, 55111
Sweden

Andreas Stephan

Jonkoping University, Jonkoping International Business School ( email )

SE-551 11 Jonkoping
Sweden
55111 (Fax)

Khanh Truong Hoang

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstraße 58
Berlin, 10117
Germany

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