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Interest rate Pass-Through in the Major European Economies - The Role of Expectations

  • Anindya Banerjee
  • Victor Bystrov
  • Paul Mizen

Much of the literature on interest rate pass through assumes banks set retail rates in relation to contemporary market rates. We argue that future rates also matter, and if forecasts of future rates are included, the empirical specifications of many previous studies are misspecified. Including forecasts requires careful choice of the data and models used to make forecasts: a large number of variables could influence future market rates, suggesting that factor forecasts method may be an appropriate method to consider. We evaluate forecasts before including them in a model of retail rate adjustment for five interest rates in five European countries and the euro area as a whole. We find a significant role for forecasts of future interest rates in determining short- and long-run pass through, and we show that models which do not include future rates do not provide accurate estimates.

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Paper provided by University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM) in its series Discussion Papers with number 10/03.

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Handle: RePEc:not:notcfc:10/03
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  1. Anindya Banerjee & Massimiliano Marcellino & Igor Masten, 2005. "Leading Indicators for Euro-area Inflation and GDP Growth," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 67(s1), pages 785-813, December.
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  3. Kerstin Bernoth & Jürgen von Hagen, 2004. "The Euribor Futures Market: Efficiency and the Impact of ECB Policy Announcements," International Finance, Wiley Blackwell, vol. 7(1), pages 1-24, 03.
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  7. Kapetanios, George & Marcellino, Massimiliano, 2006. "A Parametric Estimation Method for Dynamic Factor Models of Large Dimensions," CEPR Discussion Papers 5620, C.E.P.R. Discussion Papers.
  8. Marcellino, Massimiliano & Stock, James H & Watson, Mark W, 2005. "A Comparison of Direct and Iterated Multistep AR Methods for Forecasting Macroeconomic Time Series," CEPR Discussion Papers 4976, C.E.P.R. Discussion Papers.
  9. F. De Graeve & O. De Jonghe & R. Vander Vennet, 2004. "Competition, transmission and bank pricing policies: Evidence from Belgian loan and deposit markets," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 04/261, Ghent University, Faculty of Economics and Business Administration.
  10. Anindya Banerjee & Massimiliano Marcellino & Igor Masten, 2008. "Forecasting Macroeconomic Variables Using Diffusion Indexes in Short Samples with Structural Change," Working Papers 334, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  11. Frappa, Sebastien & Murez, Michèle & Montornès, Jérémi & Barbier de la Serre, Anne, 2008. "Bank interest rates pass-through: new evidence from French panel data," MPRA Paper 26709, University Library of Munich, Germany.
  12. Mario Forni & Marc Hallin & Marco Lippi & Lucrezia Reichlin, 2000. "The Generalized Dynamic-Factor Model: Identification And Estimation," The Review of Economics and Statistics, MIT Press, vol. 82(4), pages 540-554, November.
  13. Michael Ehrmann & Leonardo Gambacorta & Jorge Martínez-Pagés & Patrick Sevestre & Andreas Worms, 2001. "Financial Systems and the Role of Banks in Monetary Policy Transmission in the Euro Area," Banco de Espa�a Working Papers 0118, Banco de Espa�a.
  14. de Bondt, Gabe & Mojon, Benoît & Valla, Natacha, 2005. "Term structure and the sluggishness of retail bank interest rates in euro area countries," Working Paper Series 0518, European Central Bank.
  15. Kuttner, Kenneth N., 2001. "Monetary policy surprises and interest rates: Evidence from the Fed funds futures market," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 523-544, June.
  16. Leonardo Gambacorta, 2005. "How Do Banks Set Interest Rates?," Temi di discussione (Economic working papers) 542, Bank of Italy, Economic Research and International Relations Area.
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  19. Ehrmann, Michael & Worms, Andreas, 2001. "Interbank lending and monetary policy transmission - evidence for Germany," Working Paper Series 0073, European Central Bank.
  20. Marcellino, Massimiliano & Stock, James H. & Watson, Mark W., 2003. "Macroeconomic forecasting in the Euro area: Country specific versus area-wide information," European Economic Review, Elsevier, vol. 47(1), pages 1-18, February.
  21. Sander Harald & Kleimeier Stefanie, 2003. "Convergence in Eurozone retail banking? What interest rate pass-through tells us about monetary policy transmission, competition and integration," Research Memorandum 051, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
  22. Kleimeier, Stefanie & Sander, Harald, 2006. "Expected versus unexpected monetary policy impulses and interest rate pass-through in euro-zone retail banking markets," Journal of Banking & Finance, Elsevier, vol. 30(7), pages 1839-1870, July.
  23. Heffernan, Shelagh A, 1997. "Modelling British Interest Rate Adjustment: An Error Correction Approach," Economica, London School of Economics and Political Science, vol. 64(254), pages 211-31, May.
  24. Paul Mizen, 2008. "The credit crunch of 2007-2008: a discussion of the background, market reactions, and policy responses," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 531-568.
  25. Anindya Banerjee & Massimiliano Marcellino & Igor Masten, 2004. "Forecasting Macroeconomic Variables for the Acceding Countries," Working Papers 260, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  26. Weth, Mark A., 2002. "The pass-through from market interest rates to bank lending rates in Germany," Discussion Paper Series 1: Economic Studies 2002,11, Deutsche Bundesbank, Research Centre.
  27. Claudio E. V. Borio & Wilhelm Fritz, 1995. "The response of short-term bank lending rates to policy rates: a cross-country perspective," BIS Working Papers 27, Bank for International Settlements.
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