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Limited Pass-Through from Policy to Retail Interest Rates: Empirical Evidence and Macroeconomic Implications

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Abstract

In this paper we survey empirical evidence on the limited pass-through from policy to retail interest rates and summarize some recent research on potential implications for monetary policy and macroeconomic fluctuations. Empirical evidence suggests that while the pass-through is incomplete in the euro area as well as in the U.S.A., it appears to be higher in the U.S.A. This is especially true for the long-run pass-through. Research in this field suggests that a limited pass-through alters the Taylor Principle. In the case of a perfect pass-through, the Taylor Principle requires that policy rates increase by more than one-to-one with an increase in (expected) inflation. If the pass-through is incomplete, policy rates have to respond by even more to compensate for the smoothing of retail rates. However, the monetary policies currently implemented in the euro area and the U.S.A. seem to satisfy the conditions for a unique and stable equilibrium and thus avoid sunspot shocks. Furthermore, findings in the literature also show that a limited passthrough has implications for the stabilizing role of monetary policy and therefore, fluctuations arising from fundamental shocks.

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Article provided by Oesterreichische Nationalbank (Austrian Central Bank) in its journal Monetary Policy & the Economy.

Volume (Year): (2006)
Issue (Month): 4 ()
Pages: 26–36

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Handle: RePEc:onb:oenbmp:y:2006:i:4:b:2

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Keywords: Interest rate pass-through; Financial systems; Stability;

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References

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Cited by:
  1. Daniel C. Hickman & William W. Olney, 2011. "Globalization and Investment in Human Capital," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 64(4), pages 654-672, July.
  2. Mishra, Prachi & Montiel, Peter J & Spilimbergo, Antonio, 2011. "How Effective Is Monetary Transmission in Developing Countries? A Survey of the Empirical Evidence," CEPR Discussion Papers 8577, C.E.P.R. Discussion Papers.
  3. David ARISTEI & Manuela Gallo, 2012. "Interest Rate Pass-Through in the Euro Area during the Financial Crisis: a Multivariate Regime-Switching Approach," Quaderni del Dipartimento di Economia, Finanza e Statistica 107/2012, Università di Perugia, Dipartimento Economia, Finanza e Statistica.
  4. Bernhofer, Dominik & van Treeck, Till, 2013. "New evidence of heterogeneous bank interest rate pass-through in the euro area," Economic Modelling, Elsevier, vol. 35(C), pages 418-429.
  5. Prachi Mishra & Antonio Spilimbergo & Peter Montiel, 2010. "Monetary transmission in low income countries," Center for Development Economics 2010-06, Department of Economics, Williams College.

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