Banks, Low Interest Rates, and Monetary Policy Transmission

83 Pages Posted: 24 Nov 2020

See all articles by Olivier Wang

Olivier Wang

New York University (NYU) - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: November, 2020

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

Suggested Citation

Wang, Olivier, Banks, Low Interest Rates, and Monetary Policy Transmission (November, 2020). ECB Working Paper No. 20202492, Available at SSRN: https://ssrn.com/abstract=3736728

Olivier Wang (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

HOME PAGE: http://www.olivierwang.com

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