The interest rate channel constitutes a key part of monetary policy transmission, especially in countries like Sweden, where banks play a major role in financing. Reductions in policy rates normally translate into broadly similar movements in market rates, in particular into interest rates at shorter maturities which influence, via the expectations channel, interest rates at longer maturities. The development of money market rates is important for two reasons: first, they provide a price signal for many other interest rates in the economy and second, they constitute an important part of banks’ funding cost thus affecting lending and deposit rates offered to firms and households, with an ultimate impact on savings and investment decisions and real economic activity.
The financial turmoil that erupted in summer 2007 and intensified in September 2008 with the collapse of Lehman Brothers, caused financial markets in Sweden to experience considerable stress as interest rate spreads shot up and financial institutions’ access to funding was constrained. In October 2008 the Riksbank, the Swedish central bank, started a sequence of cuts in the policy rate, the repo rate, which brought it down by 450 basis points.4 Moreover, the Riksbank implemented a wide range of additional non-conventional monetary policy measures to supportthe functioning of money and financial markets. This paper aims at contributing to the assessment of monetary policy in Sweden during the global financial crisis by investigating how the interest rate pass-through worked from the repo rate to retail rates from the onset of the crisis to the end of 2009.
There is a long-standing literature on interest rate pass-through, which expanded on the back of the global financial crisis. One branch focuses on country-specific factors to explain the heterogeneity of interest rate pass-through across countries: Cottarelli and Kourelis (1994) estimate the short-and long-run pass-through from money market rates to retail rates for 31 countries and explain it with a number of structural variables such as theexistence of barriers to competition, financial market development and banking system ownershipstructure. Another branch of the literature assesses whether various economic events altered the pass-through of interest rates. A prominent example is the introduction of the euro: Toolsema et al.(2001) and de Bondt (2005) analyse whether a change in the pass-through in the euro area had occurred with the introduction of the euro. They find some evidence for a faster interest rate pass-through after the introduction of the euro. More recently, a number of studies have investigated whether the global financial crisis altered the interest rate pass-through (Jobst and Kwapil, 2008; Deutsche Bundesbank, 2009; ECB, 2009). A general finding is that the pass-through from money market to bank lending and deposit rates has worked relatively well during the financial crisis even if banks have tightened their credit supply to some extent. Nevertheless, the ability of central banks to steer short-term interest rates has been impaired due to dysfunctional money markets as evidenced by elevatedand volatile risk premia (Minegishi and Cournède, 2010). Central banks assumed the role of animportant intermediary over certain periods as unsecured lending broke down almost completely and even secured lending in the repo market was severely hampered.
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Interest Rate Pass-through During the Global Financial Crisis
