The effect of inter-country competition on interest rate pass-through in the European Union

Using monthly data on countries in the European Union (EU) over seven years, this study examines the pass-through of the Central Bank (CB) rate to retail lending interest rates. Recent advances in spatial econometric methods allows for relaxing the assumption of perfect competition in interest rates by specifically modelling the spatial interaction of countries within the EU. Questions concerning the effect of spatial interaction on the pass-through of the CB rate to the lending rates are of particular interest. The results indicate statistically significant spatial interaction among countries, which results in faster pass-through.