Time-varying cointegrating regression analysis with an application to the long-run interest rate pass-through in the Euro Area

This paper study the mechanism of transmission between the money and the retail credit markets stated in terms of the long-run relationship between the harmonized interest rates for different credit categories and for a subset of countries of the EMU (European Monetary Union). This mechanism, known as the interest rate pass-through (IRPT) phenomenon, has been analyzed in many empirical studies using a variety of econometric techniques, for different samples of countries and periods of time, and the general conclusion is that the pass-through seems to be incomplete in the long-run. Except for a few recent works, the analysis is performed on the basis on a time-invariant long-run relationship which may not be appropriate in this case and could condition this result. To evaluate the robustness of these findings we extend the analysis through a non-linear model for the long-run relationship between the money and the retail markets that incorporates in a very flexible form, and with minimum requirements on tuning parameters, the nonlinearity in the form of time-varying parameters. To that end we follow the approach initiated in Bierens (1997) and also propose some new tools to test for the existence of a stable time-varying cointegration relationship. The results obtained seems to support the former evidence of an incomplete pass-through.