Monetary policy through the “credit-cost channel”. Italy and Germany

In this paper we wish to extend the empirical content of the "credit-cost channel" of monetary policy that we proposed in Passamani and Tamborini (2005). In the first place, we replicate the econometric estimation of the model for Italy, to which we add Germany. We find confirmation that, in both countries, firms' reliance on bank loans (“credit channel”) makes aggregate supply sensitive to bank interest rates (“cost channel”), which are in turn driven by the inter-bank rate controlled by the central bank plus a credit risk premium charged by banks on firms. The second extension consists of a formal econometric analysis of the idea that the interest rate is an instrument of control for the central bank. The empirical results of the CCC model that, according to Johansen and Juselius (2003), innovations in the inter-bank rate qualify this variables as a "control variable" in the system. Hence we replicate the Johansen and Juselius technique of simulation of rule-based stabilization policy. This is done for both Italy and Germany, on the basis of the respective estimated CCC models, taking the inter-bak rate as the instrument and the inflation of 2% as the target. As a result, we find confirmation that inflation-targeting by way of inter-bank rate control, grafted onto the estimated CCC model, would stabilize inflation through structural shifts of the "AS curve", that is, the path of realizations in the output-inflation space.Macroeconomics and monetary economics, Monetary transmission mechanisms, Structural cointegration models, Italian economy, German economy

Monetary policy through the “credit-cost channel”. Italy and Germany pre and post-EMU

In this paper we present an empirical analysis of the "credit-cost channel" (CCC) of monetary policy transmission. This model combines bank credit supply, as a means whereby monetary policy affects economic activity ("credit channel"), and interest rates on loans as a cost to firms ("cost channel"). The thrust of the model is that the CCC makes both aggregate demand and aggregate supply dependent on monetary policy. As a consequence a) credit market conditions (e.g. risk spreads) are important sources and indicators of macroeconomic shocks, b) the real effects of monetary policy are larger and persistent. We have applied the Johansen-Juselius CVAR methodology to Italy and Germany in the "hard" EMS period and in the EMU period. The short-run and long-run effects of the CCC are detectable for both countries in both periods. We have also replicated the Johansen-Juselius technique for the simulation of rule-based stabilization policy for both Italy and Germany in the EMU period. As a result, we have found confirmation that inflationtargeting by way of inter-bank rate control, grafted onto the estimated CCC model, would stabilize inflation through structural shifts of the stochastic equilibrium paths of both inflation and output.Macroeconomics and monetary economics, Monetary transmission mechanisms, Structural cointegration models, Italian economy, German economy

Fiscal and monetary policy, unfortunate events, and the SGP arithmetics - Evidence from a growth-gaps model

The recent revision (March 2005) of the Stability and Growth Pact (SGP) has confirmed the 3% deficit/GDP ratio as the pillar of the excessive deficits procedure envisaged by the Maastricht Treaty for member countries of the EMU. Since the deficit/GDP ceiling is still in place, research on its implications for fiscal discipline and macroeconomic stabilization has to be pushed further. We argue that the agenda largely involves empirical matters. In particular, this paper presents an econometric estimate and simulations of a macroeconomic model of Italy and Germany aimed at addressing three issues. First, monetary and fiscal rules intercations are explictly modelled and examined in dynamic setting. Second, consistently with common perception and the new formulation of the SGP, the business cycle and the responses of policy variables are cast in terms of growth gaps, not gaps in levels, with respect to potential. Third, budgetary components (primary expenditure and total tax revenue) are examined as separate fiscal rules, which allows us to track the reaction of the fiscal stance to growth shocks more precisely, to point out several pitfalls in current measures of fiscal ratios to GDP, and suggest more accurate assessment of fiscal stances.Fiscal policy, Stability and Growth Pact

The new rules of the Stability and Growth Pact. Threats from heterogeneity and interdependence

This paper examines the new SGP rules that should govern fiscal policies of the EMU member countries by means of dynamic models of the debt/GDP ratio. The focus is on factors of heterogeneity and interdependence in the three key variables that may affect the debt/GDP evolution in a multi-country setup like a monetary union: the real growth rate, the inflation rate and the nominal interest rate on the sovereign debt stock. These factors are almost ignored in the SGP intellectual and institutional framework, but they can jeopardize the main goal of fostering convergence and keeping debt/GDP ratios equalized and stable over time. Even the return of growth, inflation and interest rates to their pre-crisis tendential values, a not so likely and imminent event, will probably be insufficient to create a favourable environment for smooth debt/GDP convergence across EMU countries.Stability and Growth Pact, Public debt management

Back to Wicksell? In search of the foundations of practical monetary policy

It is now widely held that the New Neoclassical Synthesis (NSS) offers central banks a "user friendly", though rigorous, theoretical framework consistent with current practice of systematic stabilization policy based on interest rate rules (e.g. Woodford (2003)). Particular interest and curiosity have been aroused by Woodford's argument that the NNS theory of monetary policy is in its essence a modern restatement and refinement of Wicksell's interest-rate theory of prices (1898). This paper deals with two main issues prompted by Woodford's Neo-Wicksellian revival. The first questions the consistency between the NNS and Wicksell. The second concerns the value added for monetary policy of Wicksellian ideas in their own right. Section 2 clarifies some basic theoretical issues underlying the NNS and its inconsistency with a proper Wicksellian approach, which should be based on saving-investment imbalances that are precluded by the NNS theoretical framework. Section 3 presents a proper Neo-Wicksellian dynamic model whereby it is possible to assess, and hopefully clarify, some basic issues concerning the macroeconomics of saving-investment imbalances. Section 4 examines implications for monetary policy, in particular for Taylor rules, and section 5 concludes.