Nonlinearity in the British Interest Rate Transmission Mechanism

33 Pages Posted: 2 Mar 2007

See all articles by Ana-Maria Fuertes

Ana-Maria Fuertes

Cass Business School, City University of London

Shelagh Heffernan

City University London - Sir John Cass Business School

Elena Kalotychou

Cass Business School, City, University of London

Date Written: February 2007

Abstract

This paper explores the interest rate transmission mechanism on the basis of a large disaggregated sample of British monthly deposit and loan rates 1993-2005 for seven key products. The focus is on the adjustment speed towards the long run equilibrium rate. A sizeable proportion of UK deposits and credit products are found to have a time-varying adjustment speed, driven by the change in the policy rate. Tests based on regime-switching models indicate that the adjustment speed has four states defined by the sign of the policy rate change and the sign of the gap. The magnitude of changes in the policy rate also influences the adjustment speed in a regime-switching manner, but this nonlinear aspect is less pervasive across products than the sign asymmetry. Furthermore, mainly for deposit products there is curvature in the catch-up effect towards equilibrium - the error correction is disproportionately larger for big gaps. The marked heterogeneity found across financial institutions and products in the adjustment process raises important questions about the monetary transmission and the effectiveness of monetary policy.

Keywords: Error Correction Model, Adjustment Speed, Time-variation, Regime-Switching, Curvature

JEL Classification: G20, G21, E43, E52

Suggested Citation

Fuertes, Ana-Maria and Heffernan, Shelagh A. and Kalotychou, Elena, Nonlinearity in the British Interest Rate Transmission Mechanism (February 2007). Available at SSRN: https://ssrn.com/abstract=967571 or http://dx.doi.org/10.2139/ssrn.967571

Ana-Maria Fuertes (Contact Author)

Cass Business School, City University of London ( email )

Faculty of Finance
106 Bunhill Row
London, EC1Y 8TZ
United Kingdom
+44 207 477 0186 (Phone)
+44 207 477 8881 (Fax)

HOME PAGE: http://www.city.ac.uk/people/academics/ana-maria-fuertes

Shelagh A. Heffernan

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Elena Kalotychou

Cass Business School, City, University of London ( email )

106 Bunhill Row
London, EC1Y 8TZ
Great Britain

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