Restoring euro area monetary transmission: Which role for government bond rates?

For a number of euro area periphery countries, this paper explores the stability of the link between bank lending rates and yields on sovereign bonds. A stable relationship between these interest rates is important for the ECB’s attempt to restore monetary policy transmission by conducting unconventional measures that aim at bringing down government bond rates. Using vector autoregressive models with time-varying parameters, we find that bank lending rates adjusted incompletely to changes in government bond rates before the onset of the financial crisis, while their responsiveness has even further weakened thereafter. Thus, our results suggest that periphery bank lending rates have not only decoupled from policy rates after mid-2008, but also from yields on sovereign bonds.