The impact of interest rate transmission channel on the prices development in the eurozone countries

Abstract

The purpose of this article is to investigate the monetary policy interest rate channel capabilities to influence the inflation in individual Eurozone countries. As the differences among Eurozone countries still exist, the question is whether the common monetary policy can similarly control and influence the development of inflation and economic performance in the individual union’s countries. The reaction of inflation, product and exchange rate on 1% positive interest rate shock is examined via vector autoregression (VAR) model. We implement recursive Cholesky decomposition of variance-covariance matrix of model residuals. To estimate the model, we employ monthly data for period 2000M1-2019M7 consisting of 235 observations. VAR model allows computing impulse-response functions for estimation of interest rate pass-through to macroeconomic variables. We verify the similarity of individual responses to interest rate shock of four different Euro-zone countries (Austria, Germany, France and Slovakia). The results show that the interest rate channel did not reveal particularly a strong and stable effect on the observed variables. For a reaction of prices, the theory indicates that the increase of interest rate should slow down the increase of prices causing the inflation rate to drop down. Although, the reaction of inflation on the monetary policy interest rate shock is in line with economic assumption, its intensity is very weak. It could indicate the future complication of monetary policy and its interest rate channel in affecting inflation behavior in Eurozone countries..