Interest Rate Transmission Mechanism Research Articles

Identifying Interest Rate Transmission Mechanism under a Bayesian Network

This study examines causal relationships among various short- and long-term interest rates in the Korean financial market to identify transmission channels. Monthly time series data from January 2015 to February 2024 were used, covering nine interest rates, including call rates, commercial paper (CP) rates, bank lending rates, and Treasury bond yields of different maturities. The study employs a Bayesian network to identify an acyclic causal structure between interest rates alongside a vector error correction model (VECM) to capture long-term equilibrium relationships and short-term dynamics. The findings reconfirm the traditional call rate transmission mechanism, aligning with conventional monetary policy views, demonstrating the call rate’s significant influence on bank lending rates, which affects corporate bond spreads and CP rates. Additionally, it reveals that 10-year Treasury bond yields form an independent interest rate transmission pathway, a finding not previously identified in the literature. These results underscore the need for coordinated monetary and fiscal policies due to the distinct transmission pathways of Treasury yields for sustainable macroeconomic management and growth.

On the propagation mechanism of international real interest rate spillovers: evidence from more than 200 years of data

ABSTRACT This article analyzes the real interest rate transmission mechanism across the United States, Japan, France, Germany, Holland, Italy, Spain and the United Kingdom over a period of more than 200 years. Based on a time-varying parameter vector autoregressive (TVP-VAR) connectedness methodology, the empirical results suggest that the size of the international real interest rate spillovers ranges between 30% and 75% across the sample period. Furthermore, it is shown that these spillovers increase during crisis periods, such as the two World Wars, the Great Depression of 1929, the 1980 and 1990 recessions, or the Great Financial Crisis of 2009. More interestingly, our findings illustrate the position of each of these eight countries as net transmitters or receivers of monetary policy shocks over time. Our analysis contributes to the debate on whether the conduct of monetary policy in a country should consider its international spillovers, suggesting the need for more coordinated monetary policies especially during periods of economic crises.

Shadow banking, investment and interest rate transmission: Evidence from macroprudential policy in China

In this study, we investigate the impact of shadow banking on the effectiveness of price-based monetary policy, which uses interest rates to stabilize prices as an intermediate target. Based on the data analysis of Chinese A-share listed companies from 2010 to 2021, we find that shadow banking significantly increases the sensitivity of investment to the benchmark interest rate and increases the effectiveness of the price-based monetary policy. By considering the implementation of the macroprudential assessment (MPA) system as a quasi-natural experiment, we find that the sensitivity of investment to the benchmark interest rate decreases significantly in non-state-owned enterprises (non-SOEs). Additionally, the MPA system is more likely to influence the sensitivity of investment to the interest rate in non-SOEs if they are uncollateralized, non-high-tech, or competitive. In the transition stage of promoting the price-based monetary policy, the Chinese government should actively regulate the development of shadow banking to alleviate the financing difficulties faced by non-SOEs and improve the efficiency of the interest rate transmission mechanism.

INTEREST RATE PASS-THROUGH IN UKRAINE: EVIDENCE FROM THE BANK OWNERSHIP

A full-scale war started by russian federation on February 24th, 2022 disrupted the classic monetary policy Ukraine has been conducting for years. Nevertheless, it remains critical to preserve price stability. In June 2022, NBU significantly increased its key policy rate aiming to decrease inflationary pressure through higher market interest rates. Hence, the Central bank still relies on the interest rate transmission mechanism despite the war. This research is focused on the transmission of the key policy rate changes to the commercial bank interest rates depending on the banking sector structure. We believe that this research is useful not only for the west academia but policymakers since it helps to assess monetary policy efficiency. We tested the transmission of changes in key policy rates on new loans’ and deposits’ interest rates of different maturities and groups of banks based on banks’ ownership that in the case of Ukraine closely connected to the bank's efficiency. We applied autoregressive distributed lag models with error correction forms. Our research confirms that interest rate pass-through from the key policy rate to the bank interest rates differs for banking groups. Less effective banks have more powerful transmission to their new deposits interest rates and weaker to new loans interest rates, therefore, exposed to interest risk. Moreover, according to our results, interest rate pass-through is weaker with higher maturity among both deposits and loans.

The interest rate transmission mechanism and transmission efficiency of monetary policy in China: empirical analysis based on TVP-SV-VAR model

Our theoretical model sets money market short-term interest rate as policy rate and reveals the mechanism of policy rate transmission to bond market interest rate and credit market interest rate. We apply the TVP-SV-VAR model to examine changes in transmission efficiency during these processes. We find that after central bank deregulated interest rates, the transmission efficiency of monetary policy interest rates increased significantly. The transmission of short-term interest rates to risk-free rates is the most efficient, followed by the transmission to long-term interest rates, but the transmission efficiency to loan rates is not ideal. In long sample period, the transmission of financial market benchmark interest rate SHIBOR007 to other interest rates is more desirable than IBO007 and R007. In short sample period, transmission of DR007 changes to interest rate changes in other markets is similar to SHIBOR007, indicating that using DR007 as central bank’s policy target is highly feasible.

Corporate investment and the dilemma of the monetary policy: Evidence from China

This research examines the role of corporate investment inefficiency and abnormal investment behaviors on the effectiveness of monetary policy in China’s transitional economy during 2001–2017. Using panel data regression models, we explore corporate investment inefficiency and its response to money supply and interest rates. We find that firms tend to overinvest and react abnormally to interest rates. Overall, the interest rate transmission mechanism is hindered and monetary policy becomes muddled. Our finding suggests that regulating the money supply or interest rates cannot help in coping with the dilemma between economic and financial stability until extensive financial reforms are made. Finally, we draw implications for overall financial reforms.

Research on Interest Rate Transmission Mechanism of China's Bond Market: Empirical Analysis Based on Granger Causality Complex Network

Research on Interest Rate Transmission Mechanism of China's Bond Market: Empirical Analysis Based on Granger Causality Complex Network

Monetary transmission: Are emerging market and low-income countries different?

We use the Christensen, Diebold, and Rudebusch (2011) representation of the yield curve to test the functioning of the interest rate transmission mechanism along the yield curve based on government paper in advanced, emerging market, and low-income countries. We find a robust link from the policy and short-term interbank rates to the longer-term bond yields in all countries. Two policy implications emerge. First, the presence of well-developed secondary markets does not seem to affect transmission of short term rates along the yield curve. Second, the strength of the transmission mechanism seems to be affected by the choice of the monetary regime and the level of development: advanced countries with a credible inflation targeting regime seem to have better-behaved yield curves than the countries with other monetary regimes.

China's Interest Rate Marketization and Interest Rate Transmission Mechanism: Historical Experience and Enlightenment

China's Interest Rate Marketization and Interest Rate Transmission Mechanism: Historical Experience and Enlightenment

Development of financial sector and implications on monetary transmission mechanism: evidences from Indian economy

Monetary policy is often viewed as the tool for stabilising the economy (in particular ensuring price stability). It is generally held that the stimuli of monetary policy are transmitted to the rest of the economy through the development of financial sector. The study attempts to provide empirical evidences on the implications of financial development on the effectiveness of monetary policy in the context of Indian economy over the period 1970-2016. Empirical evidences suggest that Indian economy experiences a significant expansion in the size of financial markets and institutions and it is reflected in the increasing contribution of the financial sector in gross domestic product (GDP) (i.e., depth of the financial development). A disaggregated analysis suggests that development of financial sector impedes in the process of monetary transmission mechanism in the pre-liberalisation period. However, interest rate transmission mechanism remains relatively weak in post-liberalisation period. Thus, development of financial sector does not facilitate the effectiveness of monetary policy in the context of Indian Economy.

Perspectives on Monetary Policy and Cost of Capital: Evidence from Turkey

Abstract The target of monetary policy is generally set as to create an environment of manageable employment and affordable long-term interest rates. However, priorities of central banks may differ depending on economic and financial circumstances of individual countries. Modern approaches to monetary policy transmission can be grouped under two headings, Money View and Credit View. The money view concentrates on interest rates to explain the effects of monetary policy on aggregate spending by creating an interest rate channel. The credit channel transmission approach focuses on the supply of credits by banks following a monetary policy shift in interest rates. In 2010, the Central Bank of Turkey (CBT) developed an interest rate corridor shaped by one-week and overnight repo lending to the financial banks to absorb excessive volatility caused by short-term capital inflows. Under this framework, the CBT implements its monetary policy in two ways; firstly it can alter the interest rates of weekly repo as well as O/N lending rate. Secondly, it can configure the funding structure it provides to the financial intermediaries. In such a framework, the interest rate transmission mechanism has been operated by two benchmark interest rates, one of which is the weighted average of the cost of funds provided by the CBT and the other is the interest rate in Borsa Istanbul (BIST) money market transactions at an overnight maturity. There is a strong co-movement between the interest rates and they are affected by the movements in the CBT lending rate in both directions. Interest rates applied to deposits and loans by banks are affected by the policy rate (CBT Average Funding Rate) and the market rate (BIST O/N Repo Rate).

Research on the transmission mechanism between the money market interest rates and the capital market interest rates

Purpose – The purpose of this paper is to empirically analyze the transmission mechanism between benchmark interest rate of financial market, money market interest rate and capital market yields in order to reveal the dynamic evolution characters and core influential structure between different market interest rates. Design/methodology/approach – Using Dirichlet-VAR (DVAR) model, this study analyze the relationship between markets rates according to the equilibrium model in money market and capital market. Findings – Empirical results show that the interest rate transmission mechanism functions smoothly between interest rates of different levels. Interest rate of bills issued by the central bank can effectively reflect changes in monetary policy and guide the fluidity of market, playing the anchor role in interest rate pricing. There exists a closed loop feedback between interest rate of bills issued by the central bank, and money market interest rate, as well as between money market interest rate and bond market interest rate. The former is a loop by administrative means while the latter is the one mainly affected by market-oriented means. The response by money market and bond market toward the change of benchmark interest rate is unsymmetrical as money market is more sensitive to a loose monetary policy while bond market is more sensitive to a tight monetary policy. Stock market is strongly affected by uncertainty of benchmark interest rate. Originality/value – DVAR model is the extension of research on instable data and multiple variable causality test, which expands the causality analysis between two variables to multiple variables causality impact analysis which contains non-stable and structurally instable economic data.

HYPOTHESIS TESTS ON HALL PERMANENT INCOME (HPI): THE CASE OF INDONESIA

This paper is focused on the test of Hall Permanent Hypothesis. Hall hypothesizes that economic agents have perfect information on their life time income. Since economic agents have perfect information on their life time income, they tend to hold their inter-temporal consumption to be equal. There are three ways to test the Hall hypothesis. The three ways are Dickey Fuller, Augmented Dickey Fuller, Cambell and Mankiw tests. The results are inconsistent each others. The finding tends to support that the interest rate transmission mechanism for inter-temporal consumption is not working in Indonesia. The interest rate in Indonesia tends to be higher than of the neighboring countries. The interest rate in Indonesia tends to be high because of the high inflation rate, and inefficient banking practice. It is interesting to plan further research on staggering high inflation and inefficient banking practice in Indonesia. Keywords: Hall income permanent hypothesis, inflation, Indonesia.

Monetary Transmission: Are Emerging Market and Low Income Countries Different?

We use two alternative representations of the yield curve to test the functioning of the interest rate transmission mechanism along the yield curve based on government paper in a sample of emerging market and low-income countries. We find a robust link from shortterm policy and interbank rates to longer-term bond yields. Two policy implications emerge. First, the presence of well-developed secondary financial markets does not seem to affect transmission of short term rates along the yield curve. Second, the strength of the transmission mechanism seems to be affected by the choice of the monetary regime: countries with a credible inflation targeting regime seem to have “better behaved” yield curves than those with other monetary regimes.

Monetary Transmission: Are Emerging Market and Low Income Countries Different?

We use two alternative representations of the yield curve to test the functioning of the interest rate transmission mechanism along the yield curve based on government paper in a sample of emerging market and low-income countries. We find a robust link from shortterm policy and interbank rates to longer-term bond yields. Two policy implications emerge. First, the presence of well-developed secondary financial markets does not seem to affect transmission of short term rates along the yield curve. Second, the strength of the transmission mechanism seems to be affected by the choice of the monetary regime: countries with a credible inflation targeting regime seem to have 'better behaved' yield curves than those with other monetary regimes.

A threshold cointegration analysis of interest rate pass-through to UK mortgage rates

This paper empirically analyses the interest rate transmission mechanism in the United Kingdom by exploring the pass-through of the official rate to the money market rate and of the market rate to the mortgage rate. Potential asymmetries, due to financial market conditions and monetary policy, lead to the use of a nonlinear threshold error-correction model, with hypothesis tests based on nonstandard bootstrap procedures that take into account the discrete nature of changes in the official rate. The empirical results indicate the presence of substantial asymmetries in both steps of the process, with these asymmetries depending on past changes in the money market rate and whether these are motivated by official rate changes. Generalized impulse response function analysis shows that adjustments differ with regard to the sign and magnitude of interest rate changes in a way that is consistent with conditions in the interbank and mortgage markets over the recent period.

SOUTH AFRICAN MARKET VOLATILITY, ASYMMETRY AND RETAIL INTEREST RATES PASS‐THROUGH

AbstractThe purpose of this paper is to examine the interest rate transmission mechanism for South Africa as an emerging economy in a pre‐repo and repo system. It explains how the money market rate is transmitted to the retail interest rates both in the long run and short run, and tests the symmetric and asymmetric interest rate pass‐through using the error‐correction model (ECM) and the adjusted ECM‐exponential generalised autoregressive conditional heteroscedasticity (ECM‐EGARCH) (1,1)‐M methodology. This permitted the examination of the impact of interest rate volatility, along with the leverage effect. An incomplete pass‐through is found in the short run. From the entire sample period, a symmetric adjustment is found in the deposit rate, which had upward rigidity adjustment, while an asymmetric adjustment is found in the lending rate, with a downward rigidity adjustment. All the adjustments supported the collusive pricing arrangements. According to the conditional variance estimation of the ECM‐EGARCH (1,1), negative volatility impact and leverage effect are present and influential only in the symmetric deposit interest rate adjustment process in South Africa.

Interest Rate Transmission and Volatility Transmission along the Yield Curve

In order to analyse the interest rate transmission mechanism, we study daily Euro-rates term structure for the US, Germany, and the UK between 1983 and 1997. We estimate multivariate VECM-GARCH models, which take into account moste of the usual features of financial data (non-stationarity, cointegration, heteroskedasticity, asymmetric effects) The estimates of these models, allows us to study interest rate transmission as well as volatility transmission along the yield curve. Due to the huge number of the parameters it is quite difficult to interpret the empirical result. To avoid this problem we use the impulse responses framework to examine the transmission mechanism along both the yield and volatility curves.

The Policy Interest-Rate Pass-Through in Central America

Several Central American (CADR) central banks with independent monetary policies have adopted policy interest rates as their main instrument to signal their monetary policy stances, often in the context of adopting or transitioning to inflation targeting regimes. This paper finds that the interest-rate transmission mechanism, or the pass-through of the policy rate to market rates, is generally weaker and slower in CADR than in the LA6, the countries selected as benchmarks. A variety of potential factors behind this finding are examined, including the degrees of financial dollarization, exchange rate flexibility, bank concentration, financial sector development, and fiscal dominance. Through panel data analysis, the study suggests that the transmission mechanism can be strengthened by increasing exchange rate flexibility, and, over time, by adopting measures towards reducing financial dollarization, developing the financial sector, and reducing bank concentration.

The Policy Interest-Rate Pass-Through in Central America

Several Central American (CADR) central banks with independent monetary policies have adopted policy interest rates as their main instrument to signal their monetary policy stances, often in the context of adopting or transitioning to inflation targeting regimes. This paper finds that the interest-rate transmission mechanism, or the pass-through of the policy rate to market rates, is generally weaker and slower in CADR than in the LA6, the countries selected as benchmarks. A variety of potential factors behind this finding are examined, including the degrees of financial dollarization, exchange rate flexibility, bank concentration, financial sector development, and fiscal dominance. Through panel data analysis, the study suggests that the transmission mechanism can be strengthened by increasing exchange rate flexibility, and, over time, by adopting measures towards reducing financial dollarization, developing the financial sector, and reducing bank concentration.