Time-varying mark-up and the ECB monetary policy transmission in a highly non linear framework

Abstract

This paper investigates the interest rate pass-through in eight European countries and allows for a mark-up which can be affected by country specific funding conditions and/or stochastic structural breaks. In the Southern European countries of the sample the long-run pass-through is directly affected by changes in banks' cost of funding, due to shifts in the spread between domestic and German long-term government bond interest rates. In the same way, the ESTAR/LSTAR parameterization of the short-run dynamics brings about innovative results and identifies a crucial role for the government bond spreads in countries which were involved in the recent European debt crisis. This evidence suggests that the adoption by the ECB of unconventional monetary policies, such as the QE, by lowering the spreads, may reduce the fragmentation of the banking system in the Euro Area.