Monetary policy through the “credit-cost channel”. Italy and Germany pre and post-EMU

In this paper we present an empirical analysis of the "credit-cost channel" (CCC) of monetary policy transmission. This model combines bank credit supply, as a means whereby monetary policy affects economic activity ("credit channel"), and interest rates on loans as a cost to firms ("cost channel"). The thrust of the model is that the CCC makes both aggregate demand and aggregate supply dependent on monetary policy. As a consequence a) credit market conditions (e.g. risk spreads) are important sources and indicators of macroeconomic shocks, b) the real effects of monetary policy are larger and persistent. We have applied the Johansen-Juselius CVAR methodology to Italy and Germany in the "hard" EMS period and in the EMU period. The short-run and long-run effects of the CCC are detectable for both countries in both periods. We have also replicated the Johansen-Juselius technique for the simulation of rule-based stabilization policy for both Italy and Germany in the EMU period. As a result, we have found confirmation that inflationtargeting by way of inter-bank rate control, grafted onto the estimated CCC model, would stabilize inflation through structural shifts of the stochastic equilibrium paths of both inflation and output.