International evidence on the cost channel of monetary policy

Abstract We provide evidence from advanced and emerging economies on the supply‐side effects of monetary policy, that is, the cost channel. We employ sign restrictions to identify demand‐driven and supply‐driven components of inflation and loan rates to test for the cost channel. A monetary policy tightening, by reducing banks' loan supply, increases the supply loan rate and the borrowing costs faced by firms. The subsequent contraction in aggregate supply raises supply inflation. We find this effect is larger in emerging economies. In a stylized New Keynesian model both reactions are related to the pass‐through of firms' costs to prices and banks' costs to rates.