The Impact of Central Bank Policy Rate on Financial Development: The Case of Europe

Abstract

This study investigates the influence of central bank policy rate (CBPR) on financial development for a panel of fifteen European Union economies, utilizing annual data ranging from 2002 to 2017 inclusively. To this aim, an autoregressive distributive lag model was applied and Pooled Mean Group estimates were obtained. Economic growth, innovation, globalization index, and corruption perception index were incorporated within the empirical model as control variables to refrain from omitted variable bias. Our findings indicate that CBPR is a major driver of financial development alongside reduced corruption, increased economic growth, and increased globalization in the case of Europe. Based on the empirical findings we have obtained, we offer various policy recommendations such as; following the monetary policy which will support financial development, ensuring the central bank’s independence, increasing trust in institutions, combating the informal economy, and encouraging innovations, especially in the financial sector. We discuss the policy implications of our findings in the conclusion section in more detail. © 2022, The Author(s), under exclusive license to Springer Nature Switzerland AG.