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Bank Behavior and the Cost Channel of Monetary Transmission

  • Wollmershäuser, Timo
  • Mayer, Eric
  • Hülsewig, Oliver

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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Paper provided by University of Würzburg, Chair for Monetary Policy and International Economics in its series W.E.P. - Würzburg Economic Papers with number 71.

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Date of creation: 2006
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Handle: RePEc:zbw:wuewep:71
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  11. Altig, David E & Christiano, Lawrence J. & Eichenbaum, Martin & Lindé, Jesper, 2005. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," CEPR Discussion Papers 4858, C.E.P.R. Discussion Papers.
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  17. Ibrahim Chowdhury & Mathias Hoffmann & Andreas Schabert, 2004. "Inflation Dynamics And The Cost Channel Of Monetary Transmission," Royal Economic Society Annual Conference 2004 80, Royal Economic Society.
  18. 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," Working Papers 0118, Banco de España;Working Papers Homepage.
  19. Fried, Joel & Howitt, Peter, 1980. "Credit Rationing and Implicit Contract Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(3), pages 471-87, August.
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  22. Fagan, Gabriel & Henry, Jérôme & Mestre, Ricardo, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series 0042, European Central Bank.
  23. Carlo Cottarelli & Angeliki Kourelis, 1994. "Financial Structure, Bank Lending Rates, and the Transmission Mechanism of Monetary Policy," IMF Staff Papers, Palgrave Macmillan, vol. 41(4), pages 587-623, December.
  24. Welz, Peter, 2006. "Assessing predetermined expectations in the standard sticky-price model: a Bayesian approach," Working Paper Series 0621, European Central Bank.
  25. Gabe J. de Bondt, 2005. "Interest Rate Pass-Through: Empirical Results for the Euro Area," German Economic Review, Verein für Socialpolitik, vol. 6(1), pages 37-78, 02.
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  28. Andres, Javier & Lopez-Salido, J. David & Nelson, Edward, 2005. "Sticky-price models and the natural rate hypothesis," Journal of Monetary Economics, Elsevier, vol. 52(5), pages 1025-1053, July.
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