The Reversal Interest Rate

Markus Brunnermeier and Yann Koby

No 25406, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The “reversal interest rate” is the rate at which accommodative monetary policy reverses its intended effect and becomes contractionary for lending. It occurs when banks' asset revaluation from duration mismatch is more than offset by decreases in net interest income on new business, lowering banks' net worth and tightening their capital constraints. The determinants of the reversal interest rate are 1) banks' fixed-income holdings, 2) the strictness of capital constraints, 3) the degree of pass-through to deposit rates, and 4) the initial capitalization of banks. Furthermore, quantitative easing increases the reversal interest rate and should only be employed after interest rate cuts are exhausted. Over time the reversal interest rate creeps up since asset revaluation fades out as fixed-income holdings mature while net interest income stays low. We calibrate a New Keynesian model that embeds our banking frictions and show that the economics behind the reversal interest rate carry through general equilibrium.

JEL-codes: E43 E44 E52 G21 (search for similar items in EconPapers)
Date: 2018-12
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac and nep-mon
Note: AP CF ME
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Citations: View citations in EconPapers (183)

Published as Joseph Abadi & Markus Brunnermeier & Yann Koby, 2023. "The Reversal Interest Rate," American Economic Review, American Economic Association, vol. 113(8), pages 2084-2120, August.

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Journal Article: The Reversal Interest Rate (2023)
Working Paper: The Reversal Interest Rate (2022)
Working Paper: The Reversal Interest Rate (2019)
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