ECIN Replication Package for "International Evidence on the Cost Channel of Monetary Policy"

This paper provides aggregate-level evidence from a set of 31 advanced and emerging economies that supports the existence of supply-side effects for monetary policy, i.e., the cost channel. Our methodology employs sign restrictions and historical decompositions to first separate inflation and loan rates into their demand-driven and supply-driven components. These supply-driven components (here called the supply inflation and supply loan rate, respectively) are then used to test for the cost channel. Analytically, a monetary policy tightening, by reducing banks’ loan supply, increases the supply loan rate and raises the borrowing costs faced by firms. Such an adjustment in loan rates also produces a contraction in the aggregate supply that ultimately raises supply inflation. Our estimates show that a monetary tightening increases supply inflation in all countries, but more significantly in emerging economies. Larger supply inflation occurs due to the greater responses of supply loan rates to policy rates and of supply inflation to supply loan rates. According to our stylized New Keynesian model, both reactions are potentially related to the higher pass-through of banks’ and firms’ costs to rates and prices, respectively. Finally, we find out that, on average, the size of the cost channel in emerging economies outweighs the downward inflationary pressures expected from the aggregate demand contraction. Our interpretation is that rising inflation expectations are responsible for this result.