Interest rates and structural shocks in European transition economies

Abstract

European transition economies are still suffering from negative implications of economic crisis. Significant decrease in the key interest rates was followed by reduced maneuverability of central banks in providing incentives into real economies. Low interest rate environment together with effects of quantitative easing induced economists to examine sources of interest rates volatility. Responsiveness of short-term interest rates to the structural shocks provides unique platform to investigate sources of their unexpected volatility and associated effects on monetary policy decision making. Moreover, sources of interest rates volatility may help to reveal side effects of the exchange rate regime choice. Empirical investigation of interest rates determination under different exchange rate regimes highlights substantial implications of relative exchange rate diversity and its importance during the crisis period. In the paper we analyze sources of the short-term nominal interest rates volatility in ten European transition economies by employing SVAR methodology. We observed unique patterns of the short-term interest rates responsiveness in countries with different exchange rate arrangements that contributes to the fixed versus flexible exchange rate dilemma.