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Bank Behavior and the Cost Channel of Monetary Transmission

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Author Info
Oliver Hülsewig ()
Eric Mayer ()
Timo Wollmershäuser ()

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Abstract

This paper presents a New Keynesian model that dwells on the role of banks in the cost channel of monetary policy. Banks extend loans to firms in an environment of monopolistic competition by setting the loan rate according to a Calvo-type staggered price setting approach, which means that the adjustment of the aggregate loan rate to a monetary policy shock is sticky. We estimate the model for the Euro area by adopting a minimum distance approach. Our findings exhibit that, first, frictions on the loan market influence the propagation of monetary policy shocks as the pass-through of a change in the money market rate to the loan rate is incomplete, and, second, the cost channel is operating, but the effect is weak since inflation is driven by real unit labor costs rather than the loan rate. Our main conclusion is that the strength of the cost channel is mitigated as banks shelter firms from monetary policy shocks by smoothing lending rates.

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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 1813.

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Date of creation: 2006
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Handle: RePEc:ces:ceswps:_1813

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Related research
Keywords: bank behavior; cost channel; minimum distance estimation;

Other versions of this item:

Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Gabe J. de Bondt, 2005. "Interest Rate Pass-Through: Empirical Results for the Euro Area," German Economic Review, Blackwell Publishing, vol. 6(1), pages 37-78, 02. [Downloadable!] (restricted)
  2. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
    Other versions:
  4. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky price and limited participation models of money: a comparison," Staff Report 227, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  5. Michael Ehrmann & Leonardo Gambacorta & Jorge Martinez-Pages & Patrick Sevestre & Andreas Worms, 2001. "Financial systems and the role of banks in monetary policy transmission in the Euro area," Working Paper Series 105, European Central Bank. [Downloadable!]
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  6. Gali, Jordi & Gertler, Mark & Lopez-Salido, J. David, 2001. "European inflation dynamics," European Economic Review, Elsevier, vol. 45(7), pages 1237-1270. [Downloadable!] (restricted)
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  7. Chowdhury, Ibrahim & Hoffmann, Mathias & Schabert, Andreas, 2006. "Inflation dynamics and the cost channel of monetary transmission," European Economic Review, Elsevier, vol. 50(4), pages 995-1016, May. [Downloadable!] (restricted)
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  8. David E. Altig & Lawrence J. Christiano & Martin Eichenbaum & Jesper Linde, 2004. "Firm-specific capital, nominal rigidities, and the business cycle," Working Paper 0416, Federal Reserve Bank of Cleveland. [Downloadable!]
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  9. Glenn D. Rudebusch & Jeffrey C. Fuhrer, 2002. "Estimating the Euler equation for output," Working Papers in Applied Economic Theory 2002-12, Federal Reserve Bank of San Francisco. [Downloadable!]
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  10. Marco Del Negro & Frank Schorfheide & Frank Smets & Raf Wouters, 2005. "On the fit and forecasting performance of New-Keynesian models," Working Paper Series 491, European Central Bank. [Downloadable!]
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  11. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March. [Downloadable!] (restricted)
  12. Frank Smets & Rafael Wouters, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 171, European Central Bank. [Downloadable!]
  13. Gabriel Fagan & Jérôme Henry & Ricardo Mestre, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series 42, European Central Bank. [Downloadable!]
  14. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October. [Downloadable!] (restricted)
  15. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Pierre-Richard Agénor & Peter Montiel, 2008. "Monetary Policy Analysis in a Small Open Credit-Based Economy," Open Economies Review, Springer, vol. 19(4), pages 423-455, September. [Downloadable!] (restricted)
    Other versions:
  2. Totzek, Alexander, 2008. "The Bank, the Bank-Run, and the Central Bank: The Impact of Early Deposit Withdrawals in a New Keynesian Framework," Economics Working Papers 2008,20, Christian-Albrechts-University of Kiel, Department of Economics. [Downloadable!]
  3. Aqib Aslam & Emiliano Santoro, 2008. "Bank Lending, Housing and Spreads," Discussion Papers 08-27, University of Copenhagen. Department of Economics, revised Nov 2008. [Downloadable!]
  4. Kilponen , Juha & Milne, Alistair, 2007. "The lending channel under optimal choice of monetary policy," Research Discussion Papers 33/2007, Bank of Finland. [Downloadable!]
  5. Steffen Henzel & Oliver Hülsewig & Eric Mayer & Timo Wollmershäuser, 2007. "The Price Puzzle Revisited: Can the Cost Channel Explain a Rise in Inflation after a Monetary Policy Shock?," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
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