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Confidence and Monetary Policy Transmission

Empirical results for the euro area show that an important channel through which monetary policy – measured traditionally by the short-term interest rate as well as by the Eurosystem balance sheet total – affects economic growth is the confidence of borrowers as well as of lenders. Impulse responses and variance decompositions show that this channel is most effective via the short-term interest rate. Moreover, the state of confidence significantly matters for economic growth, particularly for investment (compared to private consumption) and for industry value added (compared to services). The findings are robust across adding other transmission variables, impulse definition, and other measures of monetary policy and confidence. The importance of a “feel good” factor among lenders provides new empirical evidence in the old debate that the situation of the financial sector does matter for growth.