Michael Ehrmann

Financial Systems and the Role of Banks in Monetary Policy Transmission in the Euro Area

This paper offers a comprehensive comparison of the structure of banking and financial markets in the euro area. Based on this, several hypotheses about the role of banks in monetary policy transmission are developed. Many of the predictions that have been proposed for the U.S. are deemed unlikely to apply in Europe. Testing these hypotheses we find that monetary policy does alter bank loan supply, with the effects most dependent on the liquidity of individual banks. Unlike in the US, the size of a bank does generally not explain its lending reaction. We also show that the standard publicly available database, BankScope, obscures the heterogeneity across banks. Indeed, for several types of questions BankScope data suggest very different answers than more complete data that reside at national central banks.

Taking Stock: Monetary Policy Transmission to Equity Markets

This paper analyses the effects of U.S. monetary policy on stock markets.We present evidence that individual stocks react in a highly heterogeneous fashion to U.S. monetary policy shocks and relate this heterogeneity to financial constraints and Tobins q. First, we show that there are strong industry-specific effects of U.S. monetary policy. Second, we also find that for the 500 individual stocks comprising the S&P500 the firms with low cash flows, small size, poor credit ratings, low debt to capital ratios, high price-earnings ratios, or a high Tobins q are affected significantly more by monetary policy.

Global financial transmission of monetary policy shocks

The paper analyses the transmission of US monetary policy shocks to global equity markets and the macroeconomic determinants of the underlying transmission process. We show that there is a substantial cross‐country heterogeneity in reactions across 50 equity markets worldwide, with returns falling on average around 2.7% in response to a 100 basis point tightening of US monetary policy, but ranging from a zero response in some to a reaction of 5% or more in other markets. As to the determinants of the strength of transmission to individual countries, we test the relevance of their macroeconomic policies and the role of real and financial integration. We find that in particular the degree of global integration of countries – and not a countrys bilateral integration with the United States – is a key determinant for the transmission process.

Euro Area Inflation Differentials

We build a stylised 12-country model of the euro area and use it to analyse how differences in national inflation and growth rates arise within the European Economic and Monetary Union (EMU). We find that the main source of differentials in the early years of the EMU have been aggregate demand shocks, followed by cost-push shocks; euro exchange rate shocks come third. Among the propagation mechanisms a key role is played by inflation persistence; for plausible parameter values even small changes in persistence can produce a dramatic increase in the differentials. Finally, we also find that a tight control of average area-wide inflation around a target tends to reduce the differentials as well.

Equal Size, Equal Role? Interest Rate Interdependence between the Euro Area and the United States

This paper investigates whether the degree and the nature of economic and monetary policy interdependence between the United States and the euro area have changed with the advent of EMU. Using real-time data, it addresses this issue from the perspective of financial markets by analysing the effects of monetary policy announcements and macroeconomic news on daily interest rates in the United States and the euro area. First, the paper finds that the interdependence of money markets has increased strongly around EMU. Although spillover effects from the United States to the euro area remain stronger than in the opposite direction, we present evidence that US markets have started reacting also to euro area developments since the onset of EMU. Second, beyond these general linkages, the paper finds that certain macroeconomic news about the US economy have a large and significant effect on euro area money markets, and that these effects have become stronger in recent years. Finally, we show that US macroeconomic news have become good leading indicators for economic developments in the euro area. This indicates that the higher money market interdependence between the United States and the euro area is at least partly explained by the increased real integration of the two economies in recent years.

Convergence and Anchoring of Yield Curves in the Euro Area

We study the convergence of European bond markets and the anchoring of inflation expectations in the euro area using high-frequency bond yield data for France, Germany, Italy, and Spain as well as smaller euro area countries and a control group comprising the UK, Denmark, and Sweden. We find that Economic and Monetary Union (EMU) has led to substantial convergence in euro area sovereign bond markets in terms of interest rate levels, unconditional daily fluctuations, and conditional responses to major macroeconomic announcements. Our findings also suggest a substantial increase in the anchoring of long-term inflation expectations since EMU, particularly for Italy and Spain, which have seen their long-term interest rates become much lower, much less volatile, and much better anchored in response to news. Finally, we present evidence that the elimination of exchange rate risk and the adoption of a common monetary policy were the primary drivers of bond market convergence in the euro area, as opposed to fiscal policy restraint and the loose exchange rate peg of the 1990s. JEL no: E52, E58

Firm Size and Monetary Policy Transmission — Evidence from German Business Survey Data

Using business survey data on German manufacturing firms, this paper provides tests for hypotheses formulated in capital market imperfection theories that predict distributional effects in the transmission of monetary policy. The business conditions of small firms are found to be somewhat more sensitive to monetary policy shocks than those of large firms, also when accounting for demand differences. These effects are reinforced in business cycle downturns.

Monetary transmission in the euro area: early evidence

We examine the euro area monetary policy transmission process using post-1999 data, with two main questions in mind: has it changed after – and because of – economic and monetary union (EMU) and, if so, is it becoming homogeneous across countries? Given the data limitations, we concentrate on three components of the transmission mechanism: the banking, the interest rate and the asset market channels. We find evidence that the transmission through banks has become more potent and homogeneous across countries. On the financial market channels, our evidence is somewhat weaker but suggestive. The interest rate channel appears to have changed even before EMU, and now affects national economies in a broadly similar way. The asset market channel (proxied by the stock market effects of monetary policy) also seems to work rather homogeneously across national markets (no comparison with pre-EMU is available here). A positive answer to both questions raised above represents, in our view, the best working hypothesis under current knowledge.

The Role of Central Bank Transparency for Guiding Private Sector Forecasts

There is a broad consensus in the literature that costs of information processing and acquisition may generate costly disagreements in expectations among economic agents, and that central banks may play a central role in reducing such dispersion in expectations. This paper analyses empirically whether enhanced central bank transparency lowers dispersion among professional forecasters of key economic variables, using a large set of proxies for central bank transparency in 12 advanced economies. It finds evidence for a significant and sizeable effect of central bank transparency on forecast dispersion, be it by means of announcing a quantified inflation objective, other forms of communication, or by publishing central banks’ inflation and output forecasts. However, there also appear to be limits to central bank transparency, with decreasing marginal returns to enhancing (economic) transparency, and given our findings that disagreement among inflation expectations in the general public is not affected by the various central bank transparency measures analyzed in this paper.

Monetary Policy Transmission in the Euro Area: New Evidence From Micro Data on Firms and Banks

This paper presents an overview of the results of a research project on monetary transmission pursued by the Eurosystem, which has analysed micro data on firms and banks in several countries of the euro area in great detail. There is strong empirical support for an interest rate channel working through firm investment. Furthermore, a credit channel can be identified with firm micro data. On the bank side, there is evidence that lending reacts differently to monetary policy according to bank balance sheet characteristics. In particular, banks that have a less liquid asset composition show a stronger loan supply response. This finding may be due to banks drawing on their liquid assets to cushion the effects of monetary policy on their loan portfolio, which is in line with the existence of close relationships between banks and their loan customers.