The role of a discount rate in a transmission mechanism and its influence on the deposits market

Abstract

The article focuses on the analysis of the dynamics of the discount rate as a key monetary policy tool. It examines how the discount rate, through the transmission mechanism, influences fluctuations in interbank interest rates and the bank deposit market. The study examines the indicators of Ukraine's banking sector over the past 5 years, considering the impact of external shocks such as the COVID-19 pandemic and large-scale armed aggression by Russia. These factors have resulted in inflation and interest rate growth in developed countries, a stronger US dollar, decreased business activity, and negative business expectations, all of which significantly impact Ukraine's small open economy. Consequently, the National Bank of Ukraine has implemented measures to stimulate creditworthiness, support entrepreneurship during lockdowns, and ensure access to profitable long-term financing, while also maintaining stability in the banking system during crises. The study analyzes the effects of the regulator's policy of increasing the discount rate and curtailing anti-crisis measures to curb inflation, which have had positive consequences during the most challenging crisis periods and the initial stages of economic recovery. It also highlights macroeconomic measures and restrictions imposed by the central bank to stabilize the economy in the face of a full-scale Russian military invasion, including state interventions to offset costs in priority areas of the economy. Despite the ongoing impact of tight monetary policy on the domestic market, a potential slowdown in inflation, stabilization of the exchange rate, and the funding market may contribute to the revival of the interbank market, bank lending, and potential revision of the discount rate and/or dollar exchange rate in the long term. The study further conducts a simulation of the balanced level of the discount rate using the classic Taylor equation, indicating the possibility of revising and gradually relaxing tight monetary conditions in 2023. However, it suggests that the rate reduction may be moderate, around 0.5-1.5 percentage points in the short term and 2 to 4 percentage points in the medium term. Overall, the study underscores the importance of the discount rate as a monetary policy tool and its implications for Ukraine's banking sector, given the external shocks and challenges faced by the country.