Are interest rate changes comoving with financial cycle?

Abstract

We explore to what extent official interest rate changes can potentially in a procyclical manner impact different financial cycle indicators (credit/GDP, debt service ratio, house prices and stock market indices). We test this on data covering 1995−2016 in 21 countries and the euro area using the Concordance index and Monetary policy procyclicality ratio. Results show that this was not a widespread phenomenon, but there was significant heterogenenity across countries. The procyclicality of interest rate changes was usually higher when financial cycle gaps were increasing and lower when they were decreasing. On average, central banks in several larger economies were running potentially less procyclical monetary policy than those in the smaller ones. The resulting propensity of conflicts between achieving price and financial stability by central banks was low, as only in 10% of the cases the objectives were conflicting (usually when inflation was below the target and the credit cycle was in an expansion phase).

Performances of selected European economies in achieving their inflation targets: The non-stationary discrete choice model approach

“…The overall conclusion is that IT is not supposed to be the best monetary strategy for all countries, but the emerging economies can anchor the inflation when the economy has hit by the exogenous uncertainties. Smaga (2021) analysed potential procyclicality of the official interest rate changes towards the financial cycle on data covering the period of 1995-2016 in 21 countries (among which were Czech Republic, Hungary and Poland) and the euro area. Based on the matrix of potential relations between IT strategy and financial cycle phase, the conclusion is that the price and financial stability objectives were conflicting only in 10% of the cases, usually when inflation was below the target and the credit cycle was in expansion.…”

“…These countries are analysed as a group and the common link is generalization to all developing countries. Most of the above-mentioned research studies are concerned with the three EU countries (Jonas -Mishkin 2005;Batini -Laxton 2007;Lin -Ye 2009;Ayres et al 2014;Hove et al 2017;Kim -Yim 2020;Smaga 2021;Duong 2021). However, Serbia is also included in a few panels (Yamada 2013;Nojkovi c -Petrovi c 2015;Wang 2016;Ardakani et al 2018).…”