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
Date Written: March 29, 2017
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: Suggested Citation