Interest Rate Deregulation: Monetary Policy Efficacy and Rate Rigidity

Abstract:     
This paper examines the effects of interest rate regulation, and subsequent deregulation, on the efficacy of monetary policy and rigidity of retail bank deposit rates in Hong Kong. Using an error correction model, we find that interest rate deregulation increases the efficacy of monetary policy by improving the correlation between retail bank deposit rates and market interest rates and increasing the degree of long-term pass-through for retail bank deposit rates. Our study also shows that the adjustments in retail bank deposit rates are asymmetric and rigid upwards during the regulated period, but tend to be rigid downwards during the deregulated period. The spreads between retail bank deposit rates and market rates have also tightened sharply after the removal of interest rate controls.

Keywords: Regulation, Monetary policy transmission, Interest rate pass-through, Rate rigidity, Asymmetric adjustment, Error correction, Threshold autoregressive model, Bank deposit rates

JEL Classification: E43, E52, G21, G28

Accepted Paper Series