Financial fragmentation and the monetary transmission mechanism in the euro area: a smooth transition VAR approach

Kotz Hans-Helmut, Willi Semmler and Tahri Ibrahim ()
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Kotz Hans-Helmut: Harvard University, Cambridge, MA, USA
Tahri Ibrahim: The New School for Social Research, New York, NY, USA

Studies in Nonlinear Dynamics & Econometrics, 2018, vol. 22, issue 5, 19

Abstract: This paper investigates the effect of financial fragmentation on the monetary transmission mechanism in different Euro area economies, categorized into two groups: countries considered as “core” economies and countries characterized as “peripheral” economies. We analyze the effects of financial fragmentation on the monetary transmission mechanism through the traditional interest rate channel. To gauge the impact of changes in policy rates on the behavior of real variables such as aggregate output and employment we use a Smooth Transition VAR (VSTAR) model. Employing a nonlinear multivariate time series approach helps us capture the regime-dependent dynamics of the variables under study. The results obtained show that money market rates targeted by the central bank do not completely pass through to banks’ lending rates to firms, particularly in a financially fragmented environment. This finding supports the hypothesis of an impairment of the monetary transmission mechanism as a result of financial fragmentation. Given this impairment in some sectors and regions an accompanying credit volume policy might have been appropriate.

Keywords: financial crisis; generalized impulse response analysis; interest rate pass-through; monetary policy transmission mechanism; multivariate nonlinear model (search for similar items in EconPapers)
JEL-codes: C32 C51 E43 G01 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1515/snde-2017-0097

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