Liquidity and monetary transmission: a quasi-experimental approach

Sam Miller () and Boromeus Wanengkirtyo
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Sam Miller: Alan Turing Institute

No 891, Bank of England working papers from Bank of England

Abstract: In the face of lower real interest rates, central bank balance sheets are likely to remain larger relative to pre-crisis levels, resulting in greater banking system liquidity. However, there is little evidence on the impact of higher liquidity on credit supply and the monetary transmission mechanism in the ‘new normal’. We exploit a novel dataset on bank liquidity positions arising from a unique regulatory regime and combine it with a highly-detailed, loan-level administrative dataset on UK mortgages. Using the design of quantitative easing auctions as an instrument for liquidity to address endogeneity, we find that more liquid banks charge slightly higher mortgage interest rates, and pass on significantly less changes in risk-free rates. We explain this through bank behaviour that attempts to preserve net interest margins in the face of holding low-yielding liquidity. Consistent with this, we find excess liquidity leads to reaching-for-yield responses in banks’ mortgage risk-taking. Additionally, the results shed light on the optimal mix between (un)conventional monetary policy tools. Policies that boost bank net interest margins are more likely to help the transmission of risk-free rates to lending rates.

Keywords: Bank liquidity; interest rate pass-through; monetary policy (search for similar items in EconPapers)
JEL-codes: E52 E58 G21 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2020-11-20
New Economics Papers: this item is included in nep-cba, nep-eec, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0891

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