Endogenous monetary policy effectiveness

Valerio Scalone and Silvana Tenreyro

No 3281, Working Paper Series from European Central Bank

Abstract: How does the effectiveness of monetary policy vary over the policy cycle? Do tightenings and loosenings have symmetric effects on the macroeconomy? This paper addresses these questions using a nonlinear empirical framework that allows financial exposure to evolve endogenously in response to macroeconomic conditions and monetary policy changes. We provide new evidence on how monetary policy effectiveness varies over the policy cycle and across economic states. We find that i) monetary policy transmits more strongly to the real economy in periods of elevated private-sector financial exposure; ii) tightening cycles increase financial exposure in the short run, which in turn amplifies the effect of further interest rate increases, whereas loosening cycles lower financial exposure, increasingly dampening the effect of interest rate cuts; iii) tightening during economic downturns further intensifies debt-servicingpressures, making monetary policy even more potent; instead, when the tightening occurs during expansions, monetary policy effectiveness is not materially affected. JEL Classification: E3, E44, G01, G21

Keywords: monetary policy; monetary policy transmission; non-linear models (search for similar items in EconPapers)
Date: 2026-09
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20263281

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