Federal Funds Rate Spillover to ECB Interest Rate: Are Macroeconomic Fundamentals Important?

Abstract

This paper examines the spillover effects of the monetary policy from federal funds rate (FFR) to European Central Bank (ECB) interest rate. The study implements a regression model to examine the pass-through effect between the two interest rates. Using quarterly data for the period 1999:1-2019:1 the estimated results indicate a statistically significant relationship between the Federal Funds Rate and the European Central Bank interest rate The Granger causality tests suggest that the causality runs from FFR to ECB interest rate. The responsiveness of the ECB interest rate depends on US macroeconomic fundamentals rather than European fundamentals. More importantly, this responsiveness depends on the monetary policy stance in the US economy. A contractionary monetary policy in the US economy is accompanied with higher responsiveness of the ECB interest rate. Additionally, the results suggest the higher the inflation in the US economy, the higher the responsiveness of the ECB interest rate would be.