Interest Rate Pass-Through: A Synthesis of Empirical Analyses

Abstract

The interest rate pass-through describes how sensitive lending rates in an economy are to changes in the monetary policy rate. The effectiveness of the pass-through determines how successful the monetary policy could be in controlling the credit cycle, business cycle, and inflation. Therefore, central bankers around the world are greatly interested in assessing this transmission. There is no unified consensus about how strong this transmission is, including in different country’s contexts. The empirical literature reports different sizes of the pass-through across countries and lending rate categories. To synthesize the results of the literature, this thesis conducts a meta-regression analysis of available empirical estimates. The analysis suggests that pass-through tends to be incomplete in general and dependent on the level of financial development, trade openness and institutions. We examine whether the interest rate pass-through in the Czech Republic is similarly dependent on the macro-financial environment. Namely, the thesis examines how the monetary policy rate affects the interest rates on consumer, mortgage, small and medium enterprises (SME), and corporate loans in the Czech Republic. In addition, the thesis tests whether macro-financial factors such as the credit risk, government bonds rate, bank competition, foreign currency (FX) interventions, and deposit structure affect interest rate pass-through. It uses the autoregressive distributed lag (ARDL) modelling approach and verifies the reliability of the estimates for the Czech Republic using a battery of stability tests. The results imply that commercial banks price the consumer loans largely independent from the monetary policy rates. Banks could price the mortgage loans largely based on the government bonds yields, which represent the cost of funds for those loans. The pass-through to SME lending rates depends most on the bank deposit structure. A higher share of deposits lowers the pass-through to SME rates. The meta-regression results and ARDL estimates for the Czech Republic suggest a stable and nearly complete pass-through to the corporate lending rates. The pass-throughts to other lending rates could be more context dependent and less reliable. For instance, the pass-through to mortgage lending rates in the Czech Republic has been markedly affected by the onset of the global financial crisis (GFC). From among the structural factors, an increasing credit risk, trade openness, stock market capitalization, and independence of monetary policy may substantially reduce the strength of interest rate pass-through.