Time varying cointegrating regression analysis with an application to the long run interest rate pass through in the Euro Area
This paper study the mechanism of transmission between the money and the retail credit markets stated in terms of the long run relationship between the harmonized interest rates for different credit categories and for a subset of countries of the EMU (European Monetary Union) This mechanism, known as the interest rate pass through (IRPT) phenomenon, has been analyzed in many empirical studies using a variety of econometric techniques, for different samples of countries and periods of time, and the general conclusion is that the pass through seems to be incomplete in the long run. Except for a few recent works, the analysis is performed on the basis on a time invariant long run relationship which may not be appropriate in this case and could condition this result. To evaluate the robustness of these findings we extend the analysis through a non linear model for the long run relationship between the money and the retail markets that incorporates in a very flexible form, and with minimum requirements on tuning parameters, the nonlinearity in the form of time varying parameters. To that end we follow the approach initiated in Bierens (1997) and also propose some new tools to test for the existence of a stable time varying cointegration relationship. The results obtained seems to support the former evidence of an incomplete pass through.