European Central Bank blog finds US economic policy uncertainty reduces euro area corporate lending and weakens monetary policy transmission

The European Central Bank published research showing that heightened economic policy uncertainty in the United States spills over into the euro area by reducing bank lending to firms through both weaker loan demand and tighter loan supply, weighing on investment and making monetary policy rate cuts less effective. Using aggregate euro area data since 2003 and a structural Bayesian Vector Autoregression, the authors estimate that a one standard deviation US uncertainty shock slows loan growth with effects building over time and peaking at around 0.5 percentage points about two years after the shock, with an additional contraction of about 0.3 percentage points when financial market volatility is high. Granular Anacredit loan-level evidence indicates euro area banks cut credit supply even after controlling for firm demand and relationships, with stronger effects for banks more exposed to the US dollar, which also raise interest rates on new loans and shorten maturities, particularly for firms trading more with the United States; bank balance sheet characteristics matter, as lower-liquidity banks see about a 1 percentage point larger decline in loan growth than higher-liquidity peers, and banks with higher non-performing loan shares also contract more. Firm-level results suggest that when uncertainty is elevated, the investment response to a 100 basis point short-term rate cut is about 20% lower, especially for investment-intensive firms.