Inflation and Floating Rate Loans: Evidence from the Euro Area

Abstract

We provide novel evidence on the supply-side transmission of monetary policy through a floating-rate channel. After a rate hike, firms with floating-rate loans keep prices elevated to offset higher borrowing costs, thereby reducing the effectiveness of monetary policy. Using monthly data on product-level prices, industry-level inflation rates and the euro-area credit register from 2021 to 2023, we find that the short-run impact of monetary tightening on inflation is 50\% smaller when firms rely on floating-rate loans. This effect is stronger for firms that rely more on working capital to finance production and when they can easily pass on higher prices to their sticky customer base (customer capital). To address the selection of firms into floating-rate loans, we exploit bank-side factors in the lending relationship. Firms more exposed to floating-rate loans increase their mark-ups more during the rate tightening, but also see higher funding costs. Overall, if firms across the euro area had a lower reliance on floating-rate loans, inflation would have been 0.8 percentage points lower in 2022-2023.