Does Economic Policy Uncertainty Impact the Pass-Through of the Repo Rate to the Bank Lending Rates?

Abstract

Evidence shows that economic policy uncertainty (EPU) shocks directly impact the lending rate dynamics and the effects differ, depending on the persistence of the economic policy uncertainty shock. The persistently rising (declining) EPU shock leads to persistent increase (decrease) in the lending rates. This finding implies that the persistence of the EPU shocks matters for the evolution of the lending rates. In addition, evidence shows that the actual rise in lending rate exceeds the counterfactual due to the repo rate tightening shocks, when the elevated EPU channel is operational in the model. This suggests that the elevated EPU amplifies the increase in the lending rate to positive repo rate shock. By contrast, the negative EPU channel dampens the increases in lending rate to positive repo rate shocks.