Is Monetary Policy Always Effective? Incomplete Interest Rate Pass-through in a DSGE Model

In the new CAMP working paper 09/2019, Binning, Bjørnland and Maih estimate a regime-switching DSGE model with a banking sector to explain incomplete and asymmetric interest rate pass-through. They find interest rate pass-through to be mostly incomplete, but with the magnitude of the pass-through depending on the shocks that hit the economy. When at the zero lower bound the shocks create asymmetric dynamics, which the incomplete pass-through exacerbates. They further find that the pass-through is nonlinear with respect to the other policy parameters. In particular, the value of the interest rate smoothing dramatically changes the profile of the interest rate pass-through with respect to the other policy parameters. Putting their results together, they show that policy is less effective under incomplete pass-through.

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