Cross-country panel analysis justifying tighter control over short-term interest rates

Abstract

These days, many central banks have achieved a high degree of control over their operational targets, and the short-term interest rates have been tightly stabilized around their target rates. The paper investigates whether such an achievement at the operational level can improve the monetary policy effectiveness, focusing on the policy rate pass-through to the bank lending rate. In doing so, the paper first shows that the policy rate pass-through to the bank lending rate improves as the interbank market interest rate is contained in a narrower band by developing a minimal static model for banks. Then, the paper empirically tests the theoretical relationship using cross-country panel data. The results consistently suggest that the credible operational framework under which the central bank consistently achieves its operational target interest rate is essential to keeping the interest rate channel effective.