Dynamic hierarchical models for monetary transmission

Monetary policies, either actual or perceived, cause changes in monetary interest rates. These changes impact the economy through financial institutions, which react to changes in the monetary rates with changes in their administered rates, on both deposits and lendings. The dynamics of administered bank interest rates in response to changes in money market rates is thus essential to examine the impact of monetary policies on the economy. Chong et al. (2006) proposed an error correction model to study such impact, using data previous to the recent financial crisis. Parisi et al. (2015) analyzed the Chong error correction model, extended it and proposed an alternative, simpler to interpret, one-equation model, and applied it to the recent time period, characterized by close-to-zero monetary rates. In this paper we extend the previous models in a dynamic sense, modelling monetary transmission effects by means of dynamic linear models. The main contribution of this work consists in a novel methodology that provides a mechanism to identify the time dynamics of interest rates, linking them to monetary rates and to macroeconomic, countryspecific variables. In addition, it introduces a predictive performance ∗Presented at: XXIV International Rome Conference on Money, Banking and Finance, Rome; XI Convention of the Italian Association of Financial Risk Management, Milan.