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

  • Hans-Helmut Kotz , Willi Semmler EMAIL logo and Ibrahim Tahri
Published/Copyright: September 18, 2018

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.

JEL Classification: C32; C51; G01; E43

Appendix 1

Figure 1: IPI growth rate, year-on-year.
Figure 1:

IPI growth rate, year-on-year.

Figure 2: Harmonized Index of Consumer Price, monthly rate of change.
Figure 2:

Harmonized Index of Consumer Price, monthly rate of change.

Figure 3: Lending rates to Small and Medium Enterprises, Amounts of up to 1 million Euro.
Figure 3:

Lending rates to Small and Medium Enterprises, Amounts of up to 1 million Euro.

Figure 4: Unemployment rate, total.
Figure 4:

Unemployment rate, total.

Appendix 2

Table 1:

Traditional unit root tests.

Test variablesFranceGermanyIrelandItalyNetherlandPortugalSpain
IPI
ADF[−4.7856]

<(0.01)
[−5.0517]

<(0.01)
[−6.5869]

<(0.01)
[−3.8156]

(0.0194)
[−7.0426]

<(0.01)
[−6.3127]

<(0.01)
[−3.5601]

(0.0383)
PP[−288.82]

<(0.01)
[−273.8]

<(0.01)
[−236.77]

<(0.01)
[−275.65]

<(0.01)
[−206.04]

<(0.01)
[−250.96]

<(0.01)
[−287.52]

<(0.01)
Inflation
ADF[−5.6445]

<(0.01)
[−6.8151]

<(0.01)
[−4.6643]

<(0.01)
[−4.2252]

<(0.01)
[−6.6623]

<(0.01)
[−5.2778]

<(0.01)
[−4.4513]

<(0.01)
PP[−203.58]

<(0.01)
[−265.89]

<(0.01)
[−202.19]

<(0.01)
[−111.18]

<(0.01)
[−97.042]

<(0.01)
[−130.93]

<(0.01)
[−103.28]

<(0.01)
Unempl.
ADF[−3.2952][−3.5173]

(0.04239)
[−3.2233]

(0.0855)
[−4.3006]

<(0.01)
[−2.3536]

(0.428)
[−4.0267]

<(0.01)
[−2.341]

(0.4332)
PP[−108.61]

<(0.01)
[−159.96]

<(0.01)
[−64.324]

<(0.01)
[−276.52]

<(0.01)
[−147.12]

<(0.01)
[−152.71]

<(0.01)
[−34.27]

<(0.01)
Table 2:

Unit root tests for nonstationarity against LSTAR model.

Test variablesKSS ADFSollis F-testShint Inf-t-test
EONIA[−1.1986][2.3769]**[0.3802]
Spread[−1.2794]*[−0.2842][−0.3034]
  1. Below, Table 3 represents the critical values for untransformed (raw) series.

  2. % t-tests, SOLLIS F-tests & for Shintani inf-test; 200 < T = 500.

Table 3:

Asymptotic critical values of unit root tests.

ADFKSS ADFSollis F-testShint Inf-t-test
1%−2.60−2.794.241−3.21
5%−1.95−2.512.505−2.66

Appendix 3

Table 4:

Linearity tests results.

Linearity test for the LVSTAR model
FranceGermanyIrelandItalyNetherlandsPortugalSpain
LR140.61

(0.0005)
216.42 (0.0044)101.42

(0.1929)
554.30

<(0.001)
213.81

(0.0063)
116.42

(0.0319)
113.89

(0.004)
LM124.71

(0.0098)
188.96

(0.0971)
93.416

(0.381)
407.37

(0.0003)
185.68

(0.1291)
104.47

(0.1413)
104.63

(0.1388)
Rescaled LM1.62

(0.0012)
1.204

(0.0600)
1.217

(0.107)
1.241

(0.0099)
1.183

(0.0793)
1.3618

(0.0258)
1.363

(0.0252)
Wilks128.18

(0.0001)
183.70

(0.0318)
92.795

(0.080)
396.56

(0.0001)
181.39

(0.041)
106.52

(0.0098)
104.20

(0.0145)
Rao2.029

(0.0000)
1.22

(0.0000)
1.526

(0.0000)
-0.9038

(0.0000)
1.200

(0.0000)
1.5438

(0.0000)
1.4989

(0.0000)
Table 5:

Initial values for location and smoothness parameters in the LVSTAR model.

Parameters evaluation
Initial valuesLocation parameter cSmoothness parameter γ
France0.1763−0.2321
Germany0.1660−0.6101
Ireland0.16900.8916
Italy0.18002.5007
Netherlands0.16800.4389
Portugal0.19463.4012
Spain0.1663−0.0264
Table 6:

Optimized location and smoothness parameters in the LVSTAR model.

Optimized parametersLocation parameter cSmoothness parameter γ
France0.17580.7850
Germany0.15500.6180
Ireland0.16002.3314
Italy0.183012.209
Netherlands0.26391.5234
Portugal0.208030.000
Spain0.15600.8959

Appendix 4

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Supplementary Material

The online version of this article offers supplementary material (DOI: https://doi.org/10.1515/snde-2017-0097).


Published Online: 2018-09-18

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