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Pass-Through of SBP Policy Rate to Market Interest Rates: An Empirical Investigation

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  • Hanif, M. Nadim
  • Khan, Mahmood ul Hassan

Abstract

Market based implementation of monetary policy embeds a swift and complete pass-through of changes in policy rate to market interest rates. This impacts the lending and deposit rates (retail rates) of the banking system. Incomplete and slow pass-through impairs the effectiveness of monetary policy transmission mechanism. This study estimates the degree and the speed of interest rate pass-through in case of Pakistan. Monthly data on State Bank of Pakistan (SBP) policy rate, money market rates and banks’ retail lending/deposit rates from July 2001 to August 2011 is used to estimate an unrestricted autoregressive distributed lag (ARDL) model. The standard ARDL model allows for the estimation of an error correction model, which helps in differentiating short run impact of changes in policy rate from its long run impact on the banks’ lending rates. The results indicate that while there is a swift pass-through from the policy rate (T-bill rates and overnight rate) to money market rate, the impact of changes in money market rates on the bank deposit rates is not only sluggish, but also incomplete. However, banks’ lending rates on fresh loans are more responsive to changes in money market rates as the banks have the luxury to take into account the changes in opportunity cost of funding.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 39587.

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Date of creation: 20 Jun 2012
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Handle: RePEc:pra:mprapa:39587

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Keywords: Policy Interest Rate; Market Interest Rate; Monetary Policy;

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References

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  1. M. Idrees Khawaja & Sajawal Khan, 2008. "Pass-through of Change in Policy Interest Rate to Market Rates," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 47(4), pages 661-674.
  2. Angeliki Kourelis & Carlo Cottarelli, 1994. "Financial Structure, Bank Lending Rates, and the Transmission Mechanism of Monetary Policy," IMF Working Papers 94/39, International Monetary Fund.
  3. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  4. Hanif, M Nadim & Hyder, Zulfiqar & Lodhi, M Amin Khan & Khan, Mahmood ul Hassan & Batool, Irem, 2008. "A small-size macroeconometric model for Pakistan economy," MPRA Paper 22930, University Library of Munich, Germany, revised 2010.
  5. Mojon, Benoît, 2000. "Financial structure and the interest rate channel of ECB monetary policy," Working Paper Series 0040, European Central Bank.
  6. Alexander F. Tieman, 2004. "Interest Rate Pass-Through in Romania and Other Central European Economies," IMF Working Papers 04/211, International Monetary Fund.
  7. Qayyum, Abdul & Khan, Sajawal & Khawaja, Idrees, 2005. "Interest Rate Pass-through in Pakistan: Evidence from Transfer Function Approach," MPRA Paper 2056, University Library of Munich, Germany, revised 2005.
  8. Carlo Cottarelli & Angeliki Kourelis, 1994. "Financial Structure, Bank Lending Rates, and the Transmission Mechanism of Monetary Policy," IMF Staff Papers, Palgrave Macmillan, vol. 41(4), pages 587-623, December.
  9. Khan, Rana Ejaz Ali & Hye, Qazi Muhammad Adnan, 2011. "Financial Liberalization And Demand For Money: A Case of Pakistan," MPRA Paper 34795, University Library of Munich, Germany.
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Cited by:
  1. Muhammad, Omer & de Haan, Jakob & Scholtens, Bert, 2014. "Impact of Interbank Liquidity on Monetary Transmission Mechanism: A Case Study of Pakistan," MPRA Paper 56161, University Library of Munich, Germany.

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