Banks, Low Interest Rates, and Monetary Policy Transmission

This paper studies the effect of low interest rates on financial intermediation and the transmission of monetary policy. Using U.S. bank- and branch-level data, I document two new facts: first, the long-run decline in bond rates has not been fully passed through to loan rates; second, the short-run pass-through of policy rates to loan rates is lower at lower rates. To explain these facts, I build a model in which banks provide both credit and liquidity, and the nominal interest rate affects the composition of bank interest income between loan and deposit spreads. In the long run, a decline in the equilibrium real rate r* compresses deposit spreads but increases loan spreads. In the short run, the sensitivity of output to monetary shocks is dampened relative to a benchmark with perfect pass-through, and even more so the lower r* is: I find a dampening that grows from 20% to 32% as r* falls from 3% to -1%. A higher inflation target can redistribute from depositors to borrowers and enhance monetary policy transmission.