Banks, money and the zero lower bound on deposit rates

Michael Kumhof and Xuan Wang ()

No 752, Bank of England working papers from Bank of England

Abstract: We develop a New Keynesian model where all payments between agents require bank deposits, bank deposits are created through disbursement of bank loans, and banks face convex lending costs. At the zero lower bound on deposit rates (ZLBD), changes in policy rates affect activity through both real interest rates and banks’ net interest margins (NIMs). At empirically plausible credit supply elasticities, the Phillips curve is very flat at the ZLBD. This is because inflation increases NIMs, credit, deposits, and thereby output, while higher NIMs also dampen inflation by relaxing price setters’ credit rationing constraint. At the ZLBD, monetary policy has far larger effects on output relative to inflation, and inflation feedback rules stabilize output less effectively than rules that also respond to credit. For post-COVID-19 policy, this suggests urgency in returning inflation to targets, caution with negative policy rates, and a strong influence of credit conditions on rate setting.

Keywords: Banks; financial intermediation; endogenous money creation; bank loans; bank deposits; money demand; deposits-in-advance; Phillips curve; zero lower bound; monetary policy rules. (search for similar items in EconPapers)
JEL-codes: E41 E44 E51 G21 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2018-08-24, Revised 2020-11-19
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac, nep-mon and nep-pay
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Related works:
Journal Article: Banks, money, and the zero lower bound on deposit rates (2021)
Working Paper: Banks, Money, and the Zero Lower Bound on Deposit Rates (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0752

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