Interest Rate Bands of Inaction and Play-Hysteresis in Domestic Investment: Evidence for the Euro Area

39 Pages Posted: 4 Sep 2019

See all articles by Ansgar Hubertus Belke

Ansgar Hubertus Belke

University of Duisburg-Essen - Department of Economics and Business Administration; IZA Institute of Labor Economics; Centre for European Policy Studies

Coletta Frenzel Baudisch

affiliation not provided to SSRN

Matthias Göcke

University of Giessen - Department of Economics

Abstract

The interest rate represents an important monetary policy tool to steer investment in order to reach price stability. Therefore, implications of the exact form and magnitude of the interest rate-investment nexus for the European Central Bank's effectiveness in a low interest rate environment gain center stage. We first present a theoretical framework of the hysteretic impact of changes in the interest rate on macroeconomic investment under certainty and under uncertainty to investigate whether uncertainty over future interest rates in the Euro area hampers monetary policy transmission. In this non-linear model, strong reactions in investment activity occur as soon as changes of the interest rate exceed a zone of inaction, that we call 'play' area. Second, we apply an algorithm describing path-dependent play-hysteresis to estimate investment hysteresis using data on domestic investment and interest rates on corporate loans for 5 countries of the Euro area in the period ranging from 2001Q1 to 2018Q1. We find hysteretic effects of interest rate changes on investment in most countries. However, their shape and magnitude differ widely across countries which poses a challenge for a unified monetary policy. By introducing uncertainty into the regressions, the results do not change much which may be due to the interest rate implicitly incorporating uncertainty effects in investment decisions, e.g. by risk premia.

Keywords: European Central Bank, interest rate, investment, monetary policy, non-ideal relay, path-dependence, play-hysteresis, uncertainty

JEL Classification: C32, E44, E49, E52, F21

Suggested Citation

Belke, Ansgar Hubertus and Frenzel Baudisch, Coletta and Göcke, Matthias, Interest Rate Bands of Inaction and Play-Hysteresis in Domestic Investment: Evidence for the Euro Area. IZA Discussion Paper No. 12567, Available at SSRN: https://ssrn.com/abstract=3445833 or http://dx.doi.org/10.2139/ssrn.3445833

Ansgar Hubertus Belke (Contact Author)

University of Duisburg-Essen - Department of Economics and Business Administration ( email )

Universitätsstr. 9
Essen, 45141
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Centre for European Policy Studies ( email )

1 Place du Congres, 1000
Brussels, 1000
Belgium

Coletta Frenzel Baudisch

affiliation not provided to SSRN

No Address Available

Matthias Göcke

University of Giessen - Department of Economics ( email )

Licher Str. 62
Giessen, Hessen D-35394
Germany

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