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Banks, low interest rates, and monetary policy transmission

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  • Wang, Olivier

Abstract

This paper studies how low interest rates weaken the short-run transmission of monetary policy and contract the long-run supply of bank credit. As U.S. bond rates have fallen, the pass-through of monetary shocks to loan and deposit rates has weakened while the spread on U.S. bank loans has risen. I build a model in which banks earn deposit and loan spreads, deposits compete with money, and banks’ lending capacity depends on their equity. The short-run transmission of monetary policy is dampened at low rates, because deposit spreads act as a better hedge for bank equity against unexpected monetary shocks. In the long run, persistent low rates decrease banks’ “seigniorage” revenue from deposit spreads, hence bank equity and loan supply contract, and loan spreads increase. JEL Classification: E4, E5, G21

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  • Wang, Olivier, 2020. "Banks, low interest rates, and monetary policy transmission," Working Paper Series 2492, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20202492
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    Citations

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    Cited by:

    1. Jermann, Urban & Xiang, Haotian, 2023. "Dynamic banking with non-maturing deposits," Journal of Economic Theory, Elsevier, vol. 209(C).
    2. Mauricio Ulate, 2021. "Alternative Models of Interest Rate Pass-Through in Normal and Negative Territory," International Journal of Central Banking, International Journal of Central Banking, vol. 17(1), pages 3-34, March.
    3. Heider, Florian & Leonello, Agnese, 2021. "Monetary Policy in a Low Interest Rate Environment: Reversal Rate and Risk-Taking," Working Paper Series 2593, European Central Bank.
    4. Francesco D'Acunto & Daniel Hoang & Maritta Paloviita & Michael Weber, 2019. "Human Frictions to the Transmission of Economic Policy," 2019 Meeting Papers 339, Society for Economic Dynamics.
    5. Goodhart, Charles A.E. & Tsomocos, Dimitrios P. & Wang, Xuan, 2023. "Bank credit, inflation, and default risks over an infinite horizon," Journal of Financial Stability, Elsevier, vol. 67(C).
    6. Vadim Elenev & Tim Landvoigt & Patrick J. Shultz & Stijn Van Nieuwerburgh, 2021. "Can Monetary Policy Create Fiscal Capacity?," NBER Working Papers 29129, National Bureau of Economic Research, Inc.
    7. repec:zbw:bofrdp:2021_012 is not listed on IDEAS
    8. Polo, Alberto, 2021. "Imperfect pass-through to deposit rates and monetary policy transmission," Bank of England working papers 933, Bank of England.
    9. Florian Heider & Farzad Saidi & Glenn Schepens, 2021. "Banks and Negative Interest Rates," Annual Review of Financial Economics, Annual Reviews, vol. 13(1), pages 201-218, November.
    10. Yan Ji & Songyuan Teng & Robert Townsend, 2021. "Dynamic Bank Expansion: Spatial Growth, Financial Access, and Inequality," NBER Working Papers 28582, National Bureau of Economic Research, Inc.

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    More about this item

    Keywords

    deposit spread; financial intermediation; interest rate pass-through; loan spread; low interest rates;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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