Interest Rate Pass-through Research Articles

Alternative Models of Interest Rate Pass-Through in Normal and Negative Territory

In the aftermath of the Great Recession, many countries used low or negative policy rates to stimulate the economy. These policies gave rise to a rapidly growing literature that seeks to understand and quantify their impact. A fundamental step when studying the effectiveness of low and negative policy rates is to understand their transmission to loan and deposit rates. This paper proposes two models of pass-through from policy rates to loan and deposit rates that can match important stylized facts while remaining parsimonious. These models can be used to study the transition between positive and negative policy rates and to quantify the impact of negative rates on banks.

Monetary Policy and Commercial Lending Rates Nexus: Evidence from Czechia

The paper investigates the interest rate pass-through in Czechia during different monetary policy stances from April 2005 to February 2020 using structural vector auto-regressive models. The effects of changes in the European money market rate on the Czech money market rate are also observed. We estimate how the changes in monetary policy setting are transmitted to commercial lending rates for both corporate and households. The results show that the responsiveness of Czech money market rate to shocks in the Euro Area money market rate is no longer true. The pass-through from the official policy rate to the money market rate was confirmed; however, the reaction varied during different monetary policy stances. After the zero lower bound period, shocks in money market rate were found to be more important for rates on corporate loans up to 30 mil CZK. The shocks in confidence significantly contributed to the variance in changes of rates on corporate loans up to 30 mil CZK and rates on consumer loans when the monetary policy tightened after the zero lower bound period.

Asymmetric Adjustment of Interest Rate Pass-Through from Central Bank’s Policy Rate to the Market Rate: Evidence from China

The paper investigates from the policy rate to the market rates under the interest rate marketization of the People’s Bank of China (PBC) since 2014. The focus is on the pass-through of the PBC’s policy target rates pass-through to the market rates. Empirical results, on the daily basis of an error-correction model suggest that the long-run pass-through of the policy target rates pass-through to the interbank market rates are all significant. The pass-through of the policy target rates DR007 and Shibor07 to the market rates which are 7-day interbank pledged repo rate (R007) and 7-day interbank offered rate (Chibor07) are both complete and in a very short period of time. The results confirm that DR007 as the PBC’s policy target rate takes an important role in the Chinese interest rate pass-though.

Interest Rate Pass-Through and Bank Risk-Taking under Negative-Rate Policies with Tiered Remuneration of Central Bank Reserves

We identify the effects of negative interest rate policies on bank behavior using difference-in differences identification and data on all Swiss banks. First, we find that going negative can interrupt not only the pass-through from policy to deposit rates, but also that to mortgage rates. Second, banks’ ability to offset negative deposit margins with increased mortgage margins is shown to depend on market power. Third, imposing negative rates on all central bank reserves causes banks to replace one sixth with riskier assets, and cut another sixth without replacement, shortening their balance sheets. Together with increased mortgage margins and fee income, the asset replacement preserves profits, but increases financial stability risks. Fourth, mortgage margin increases, balance sheet contractions and risk increases differ from positive rate policy. Fifth, the interruption in pass-through and the risks to financial stability can be reduced by up to 90% through tiered remuneration, charging marginal reserves only.

The effectiveness of the Federal Reserve System’s monetary policy in the years 1962–2018

Background: The monetary policy of the Federal Reserve System affects the term structure of nominal interest rates as well as other asset prices, and thus influences aggregate demand and price levels through these effects. This complex process is known as the monetary transmission mechanism and the transmission process of monetary impulses changes over time. The strength of this impact is a staple subject of economic research.
 Research purpose: The aim of the article is to assess the effectiveness of the Federal Reserve System’s monetary policy transmission mechanism over the period 1962–2018. In particular, the scale and timing of the interest rate pass-through to economic activity have been examined.
 Methods: Econometric methods (the vector autoregression model) have been used. The empirical analysis was carried out based on U.S. economic statistics for the years 1962–2018, which were taken from the FRED and BEA Databases.
 Conclusions: Empirical findings reveal that the way in which the Federal Reserve System’s monetary policy influenced the U.S. economy was diversified at particular time intervals. The results imply that the effectiveness of the U.S. central bank’s interest rate policy has been decreasing since the mid-1980s. Firstly, in the period 1962–1983, the real GDP growth rate and the inflation rate were more sensitive to changes in the federal funds rate than in the period 1984–2018. Secondly, in the period 1962–1983, the effective federal funds rate had an almost threefold greater impact on economic activity and price processes. Thirdly, until the mid-1980s, the effects of monetary impulses were felt longer in the American economy than in the later period. What is more, there is no evidence to suggest that the period of historically low interest rates caused a decline in the effectiveness of the transmission of monetary policy impulses.

Hampered Interest Rate Pass-Through: A Supply Side Story?

This paper shows that the supply side of credit is a major factor for the phenomenon of hampered interest rate pass-through in monopolistic banking markets. Our data, covering all 1,555 small and medium sized banks in Germany, provides a clear way to partial out demand shocks; we are thus able to show that while market-power banks charge higher loan rates, they spare their borrowers a part of exogenous upward shifts in the yield curve and furthermore withhold a substantial part of rising market rates from their depositors. Because high market-power banks in our sample are relatively more profitable, they seem to be able to insure their relationship-customers against adverse shocks.

The Ukrainian interest rate pass-through in the post-1999 era and the effectiveness of the countercyclical monetary policy

This study investigates the nature of the Ukraine interest rate pass-through from January 2000 to November 11, 2018-the post-1999 era. The empirical results reveal a relatively high short-run interest pass-through of 0.724100 and a marginally overshooting long-run interest rate pass-through of 1.054309. The bounds test results indicate a strong long-term relationship between countercyclical monetary policy and market rates. These empirical findings suggest that the National Bank of Ukraine has been very effective in formulating and implementing its countercyclical monetary policy, in spite of the pervasive corruption, formidable political and economic challenges faced by the Ukrainian Republic over this sample period, the results are quite surprising.

Mortgage asymmetric pricing, cash rate and international funding cost: Australian evidence

This study investigates asymmetry in the interest-rate pass-through at the bank level in Australia over the period 2002:7–2015:12 in a distinctive manner. First, we examine the transmission of the foreign-funds rate, in parallel with the cash rate, to bank mortgage rates. Second, we utilize the Nonlinear Auto-Regressive Distributed Lag (NARDL) framework of Shin, Yu, and Greenwood-Nimmo (2014) in panel form to capture both the time-variation and cross-section variation within bank groups. Third, we simultaneously explore heterogeneous asymmetry in the pass-through for funding cost increases and decreases on impact, in the short term and in the long term. Our results reaffirm the asymmetric relationship between the cash rate and mortgage rates. We validate that international funding costs do indeed asymmetrically drive mortgage rates. The heterogeneous asymmetry in interest-rate pass-through found in both full- and sub-sample analyses signifies that market pricing power exists in which the major banks are the most powerful in mortgage pricing, while the smaller lenders are price-takers. These findings provide important implications for policy makers, investors, and the public.

Chinese Shadow Banking: The Case of Trust Funds

:This study provides an updated analysis of Chinese trust funds—a specialized and important type of shadow banking. This study is the first to estimate the contribution of Chinese trust funds to economic growth, and also the first to examine the association between trust funds and the volatility of Chinese stock markets. It makes a novel contribution in showing that Chinese trust loans play a negative role in interest rate passthrough from the policy rate to the lending rates of commercial banks.

Interest Rate Pass-Through in Three EU Candidate Countries: The Case of Albania, North Macedonia and Serbia

The objective of the paper is to assess the interest rate pass-through in three EU candidate countries that is Albania, North Macedonia and Serbia. We rely on an error-correction model using monthly data over the period 2005-2019. Results suggest a complete interest rate pass-through in Albania, albeit it has been weakened during the economic and financial crisis. The relatively fast speed of adjustment indicates an effective interest rate transmission channel. In the Macedonian case, the changes of the monetary policy rate are transmitted completely to the bank lending rate, but not to the bank borrowing rate. The transmission via the money market rate has improved after the global economic and financial turmoil. In the case of Serbia, the results also suggest complete interest rate pass-through indicating that the monetary policy rate changes are transmitted into retail rates offered by the banks to savers and borrowers in the long run. Nevertheless, the speed of adjustment is relatively slow. In general, the estimated speed and extent of the response of money market interest rate and bank retail interest rates to changes in the monetary policy rate gives an indication of effective interest rate transmission channel in the case of Albania and Serbia. On the other hand, it is moderately effective in the case of North Macedonia given that the central bank rate changes affect mainly bank lending rate but not borrowing rate.

Robust Monetary Policy under Discretion in a New Keynesian Model with Incomplete Interest Rate Pass-Through

This paper investigates how incomplete interest rate pass-through affects optimal discretionary policy when the policy maker fears a model misspecification. We find several points as follows. First, loan rate stickiness amplifies a cautious policy response to the cost-push shock for robust policy under discretion. Second, the welfare loss under a discretionary policy improves as loan rate stickiness increases, though the welfare loss increases as loan rate stickiness increases under commitment. Loan rate stickiness works as a kind of policy inertia under a discretionary policy, and this improves the relative gains from commitment to discretion. Moreover, the cost of robust policy under discretion is small. These results are in marked contrast to the case of commitment, where the robust policy becomes costlier as loan rate stickiness increases.

Interest rate liberalization and pass-through of monetary policy rate to bank lending rates in China

We examine whether the effectiveness of the monetary policy rate transmission differs before and after interest rate liberalization in China using the autoregressive distributed lag (ARDL) bound test and an error correction model (ECM). The results show that after liberalization the mark-up is lower, and both the long-run and short-run interest rate pass-through has become faster and more complete. We attribute our findings to the ongoing reforms of China’s banking system, which has improved the competitiveness of Chinese commercial banks.

A comment on interest rate pass-through: a non-normal approach

This paper revisits the question of interest rate pass-through from the federal funds rate to bank and open market rates from the years 1987 to 2015. We employ cointegration tests with improved testing power by using information in non-normal errors. Using this approach, we find evidence of cointegration between the federal funds rate and the prime rate, the federal funds rate and the 3-month financial commercial paper rate, but no evidence of cointegration between the federal funds rate and the 30-year conventional mortgage rate. Moreover, we estimate the degree of long-run pass-through for both the prime and commercial paper rates to be less than one. Our results confirm that there is not only significant co-movement between the federal funds rate and short-term borrowing rates, but also that interest rate pass-through, in the long run, is incomplete.

The effect of negative policy rates on the interest-rate pass-through mechanism in the eurozone

This paper examines the impact of the June 2014 switch to negative interest rates (NIRs) by the European Central Bank (ECB) on the operation of the eurozone interest-rate pass-through (IRPT) mechanism. We focus on the relationship between major central-bank policy rates and selected money-market rates. That link is identified as the first stage of the IRPT mechanism and its dynamics are analysed using Granger causality and cointegration techniques for the time period January 2000–June 2017. Our empirical findings indicate a feedback relationship between the ECB policy and the money-market rates in the period prior to June 2014, but that relationship is non-operative when considering only the period of NIRs.

The divergence of bank lending rates from policy rates after the financial crisis: The role of bank funding costs

After the global financial crisis, policy rates were cut to near-zero levels, yet, bank lending rates did not fall as much as the decline in policy rates would have suggested. If the crisis represents a structural break in the relationship between monetary policy and lending rates, how should central banks view the post-crisis transmission? This poses a major puzzle for monetary policymakers. Using a new weighted average cost of liabilities to measure banks’ effective funding costs we show a model of interest rate pass-through with dynamic panel data methods solves this puzzle, and has many other advantages over traditional approaches. It confirms central banks should focus on the cost and composition of bank liabilities, as many are now doing, to better understand and steer the dynamics of lending rates.

Decoding Policy Puzzles and Monetary Policy Transmission in Sri Lanka through Time-Varying Dynamics

This study analyses the evolution of key macroeconomic variables and their linkages to understand and resolve some of the policy puzzles in Sri Lanka and to check whether responses to monetary policy shocks exhibit any time-variation over two decades employing time-varying parameter vector autoregression with stochastic volatility (TVP-SVOL). In addition, interest rate pass-through is also measured employing Autoregressive Distributed Lag (ARDL) method to update evidence on transmission of policy rates to other interest rates, including the periods that recognizes short term interest rate as operational target of the monetary policy. The findings from the interest rate pass-through analysis reconfirms the existing evidence of complete pass-through from policy interest rates to money market interest rates and sluggish pass-through from money market rates to other market interest rates, though the size and speed of adjustment are somewhat different from past findings. The time-varying analysis of macroeconomic dynamics leads to four main conclusions. Firstly, time varying mean did not show any substantial moderation in GDP growth trend over the years though a marginal moderation is observed recently. The level and volatility of inflation exhibit systematic moderation since late 2000s. The weaker linkages of money growth with GDP growth and interest rate evolve over the years, supporting the policy move to discontinue monetary targeting. Finally, the responses of growth and inflation to monetary policy shocks show time-dependence.

Non-core liabilities and interest rate pass-through: bank-level evidence from Indonesia

ABSTRACTThe policy importance of non-core liabilities (bank liabilities other than equity and retail deposits) has risen to prominence in recent years with a number of studies highlighting it as a useful indicator of financial procyclicality and vulnerability. In this paper, we look at non-core liabilities in relation to its role in the transmission of monetary policy, particularly by examining how the interest rate channel of monetary policy is affected by non-deposit liabilities. We analyse this issue in the context of an emerging economy experience of Indonesia, which in recent years, has seen an increased reliance of its banking sector on non-core funding. Our investigation employs available bank-level data on non-core liabilities and lending rates in Indonesia over the period October 2011 to July 2016. We find that including non-core liabilities in the estimation has an effect, relative to the baseline, of stronger overall and immediate pass-through, albeit with a more sluggish adjustment towards the correction of disequilibrium in the next period. The overall effect is that non-core liabilities make the duration longer for the monetary policy rate to transmit to bank lending rates in Indonesia.

Interest rate pass-through in Morocco: Evidence from bank-level survey data

We investigate the relationship between banks’ marginal cost and retail lending rates in Morocco. The data covers the rates of new business loans for four market segments broken down by institutional sector between 2006Q2 and 2016Q4. We examine the pass-through mechanism using recently developed heterogeneous panel cointegration framework. Our findings suggest that there is a high degree of pass-through heterogeneity over bank products. The weak adjustment for short-term credit facilities and consumption loans can be explained by credit risk compensation allowing banks to reduce their exposition to systemic risks. Corporate loans are priced more competitive than household and individual entrepreneur products, suggesting that negotiation power or the competition from the borrower side matters. Overall, our results indicate that banking market contestability has improved during the last decade.

China's Interest Rate Pass-Through To Government Bonds And Monetary Independence

The monetary policy has been a main driver of China's economic growth. Strong evidence shows China's monetary policy is designed to support real GDP growth. There are various and complicated monetary transmission channels. This study examines the relation between monetary independence and interest rate pass-through to government bonds in China. The sensitivity coefficients between government bond yields and the People's Bank of China's (PBC) policy rate FR007 are obtained through a series of univariate 200-trading-day rolling regressions between bond yields with different maturities and FR007. The Monetary Independence (MI) is measured as the reciprocal of the correlation of interest rates in China and the United States. 200-trading-day correlations are calculated using daily interest rate data. A simple regressions model is employed to test the relations between sensitivity coefficients and MI. The time period is between January 4, 2013 and November 30, 2016. The empirical results show that China's monetary independence is positively associated with China's interest rate pass-through to government bonds. This relation is also robust to various tests on the presence of outliers and causality. It means that the higher China's monetary independence, the greater China's interest rate pass-through to government bonds. During March 2016 – November 2016, China had been continuously suffering great capital outflows. China's monetary independence had dropped significantly during this period, and at the same time China's interest rate pass-through to government bonds had totally disappeared. The Impossible Trinity theory may provide the answer. In reality, the Chinese authorities have helped establish multiplier mechanisms that jeopardize both monetary autonomy and exchange-rate stability. The Chinese policy-makers such as finance minister Lou Jiwei also conceded that China's monetary tools were becoming less effective. Based on this study's findings, the PBC is suggested to relax its control of the exchange rate regime in order to increase the independence of the Chinese monetary policy. Accordingly, China's interest rate pass-through to government bonds will be improved, and Chinese economic growth will be more sustainable.

Interest Rate Pass-Through in China: An Analysis of Chinese Commercial Banks

ABSTRACTThis study investigates the interest rate transmission in China. We analyze the extent to which the benchmark and wholesale interest rates are transmitted to the retail interest rates and focus particularly on the change in the interest rate pass-through after the interest rate liberalization. Using data of 16 listed banks from 2007Q1 to 2017Q3, we find that the pass-through is not yet complete. Even though interest rates have been liberalized on the policy level, the sensitivity of the retail interest rates to the wholesale rates has not increased enough as expected and may be explained by the market power of Chinese commercial banks.