Monetary tightening more effective than easing in euro area

A new study identifies significant asymmetries in how monetary policy affects the euro area economy.

Monetary tightening, such as interest rate increases, produces clear and persistent restrictive effects on credit, economic output, and inflation.

These effects are transmitted through various channels, including bank lending and borrower balance sheets.

In contrast, expansionary monetary policy, like rate cuts, yields weak or statistically insignificant effects across these same indicators.

This asymmetry is particularly pronounced in bank-based transmission channels, where easing does not generate a comparable relaxation in credit conditions.

The only consistent exception is credit demand, which shows a positive response to easing, though still smaller than the effects of tightening.

The research also finds limited evidence that these asymmetric effects vary significantly over the business cycle or at the effective lower bound of interest rates.

The paper employs a flexible non-linear mixed-frequency model to analyze monetary policy transmission, departing from previous studies that assumed specific functional forms.

This methodological approach allows the data to reveal the presence of nonlinearities without imposing prior assumptions.

The model explicitly incorporates lending via banks and utilizes data from the Eurosystem's Bank Lending Survey (BLS), which provides crucial insights into how banks adjust credit standards.

This research was conducted within the 'Challenges for Monetary Policy Transmission in a Changing World Network' (ChaMP), a collaborative effort by economists from the ECB and national central banks to revisit monetary transmission channels in the euro area amidst structural changes and evolving policy toolkits.