Monetary Policy Transmission Channels

In his latest policy statement, the RBI Governor outlined how the 100 basis points (bps) cut in the policy repo rate during the current easing cycle has been transmitted across different segments of the financial system. Money Market: Following the cumulative 100 bps cut, the weighted average call rate (WACR) eased by 108 bps. Since the February policy, the 3-month Treasury Bill yield has fallen by 110 bps, the 3-month commercial paper (CP) rate for NBFCs by 161 bps, and the 3-month certificate of deposit (CD) rate by 170 bps. This shows a rapid pass-through in short-term funding costs. Bond Market: Government securities have reacted, though with varying intensity. The 5-year G-Sec yield has dropped by 63 bps, while the 10-year benchmark (6.79 GS) yield is down by 28 bps since February. Corporate debt markets mirrored this trend, with 5-year AAA-rated corporate bond yields falling by 56 bps, signalling improved financing conditions for high-quality issuers. Credit Market: In lending, the weighted average lending rate (WALR) of scheduled commercial banks declined by 71 bps for fresh rupee loans between February and June 2025, with 55 bps of this directly due to policy rate cuts. For outstanding rupee loans, the WALR moderated by 39 bps in the same period. On the deposit side, the weighted average domestic term deposit rate (WADTDR) on fresh deposits eased by 87 bps, reflecting lower funding costs for banks. Other Channels: While the Governor did not specifically mention them, transmission is also operating through the exchange rate and asset price channels, as seen in movements in the forex market and equity valuations. Together, these developments suggest that the RBI’s earlier rate cuts are steadily permeating the economy, though the complete effects,especially in retail credit, are still unfolding.

How does monetary policy shape who gets a mortgage? 🏠💶 I’m excited to share my new working paper published by the National Bank of Belgium, co-authored with Salima OUERK. We study how ECB monetary policy surprises affect new mortgage lending across the household income distribution in France, using loan-level data from the national credit registry. We uncover a striking U-shaped pattern: ➡️ Middle-income households, especially first-time buyers, react the most to changes in financing conditions. These households, while creditworthy, remain liquidity constrained and therefore more sensitive to both monetary policy and macroeconomic signals. Our results highlight the expectations channel and the information channel: - Expansionary pure policy and forward guidance surprises boost credit demand. - Positive macroeconomic signals also raise borrowing. A one-standard-deviation expansionary surprise over two years leads to a 10% increase in new mortgage lending among middle-income households. 🔗 Read the full paper here: https://lnkd.in/eDSNiYYA

I’m excited to share my latest research on how conventional monetary policy shocks propagate through the U.S. economy. In "Exploring Monetary Policy Shocks with Large-Scale Bayesian VARs" I develop a high-dimensional Bayesian VAR that: 🎾 Provides a comprehensive Bayesian methodology and computational algorithm for assessing monetary policy in data-rich environments 🏀 Merges high-frequency Fed surprises with sign restrictions for robust shock recovery 🏈 Allows time-varying effects, stochastic volatility, and fat-tailed errors to handle pandemic-era outliers Applied to U.S. data through May 2024, the model reveals pronounced heterogeneity in CPI responses: core goods disinflated swiftly after Fed tightening, while services, especially housing, adjusted much more gradually, with these dynamics shifting markedly during the 2022-24 inflation surge. If you’re curious about the evolving transmission of monetary policy using large VAR methods, take a look: 👉 https://lnkd.in/eAXyk_gd Feedback and discussion are welcome! #BayesianVAR #MonetaryPolicy #InflationDynamics #Macroeconometrics

Mulqueeney et al. (2025) from the RBA has not received the attention it deserves. It is significant for two reasons. The first is soft launching DINGO, what seems like the RBA’s first serious attempt in years to implement a DSGE model internally(RENO’s kid). Welcome to the structural revolution the RBA. The second is the results of this model and what it is going to mean for the RBA’s thinking. For a long time MARTIN, the RBA’s “semi-structural” model has emphasised the exchange rate as the primary transmission mechanism of monetary policy. Not so says DINGO. The MARTIN model suggests that exchange rate adjustments account for approximately 2/3 of the GDP and Inflation response from monetary policy. What this means for example, if like during Covid, lot’s of other countries start raising rates and the RBA does not, the exchange rate will substantially depreciate driving an overstimulation of the economy. Since so much of exchange rate pricing happens via the USD, if that hiking cycle happens in the United States you don’t have much choice. But DINGO suggests that exchange rate adjustments account for only 1/4 of the GDP response and 1/3 of the Inflation response. This is a really, really big deal. At the very least this model is going to provoke internal discussions at the RBA de-emphasising the importance of the exchange rate channel. I hope that the RBA is able to put together a RDP on DINGO sooner rather than later. Because clearly it will take me 4 months to register it’s release and significance. #DINGO #RBA #MonetaryPolicy

RBI's repo rate cuts have seen only partial transmission thus far: Foreign Banks cut lending rates most (34 bps on outstanding loans), #PSBs & Pvt Banks less (10-19 bps) esp on fresh loans & deposits. Customers of the banking system need to wait longer for the benefits of RBI's rate cuts to accrue to them. In fact, Pvt Banks raised fresh deposit rates by 20 bps The transmission of interest rate cuts by banks has been low despite RBI cutting rates with alacrity due to several factors including: - Liquidity: Excess liquidity in the system can reduce banks' reliance on RBI funding, diminishing the impact of rate cuts. - Risk aversion: Banks may be cautious in lending, prioritizing safer investments. - There are also inbuilt rigidities in bank asset-liabilities that affect transmission of rate cuts : 1. Sticky deposits: Banks often don't pass on rate cuts to depositors to maintain deposits and avoid losing customers. 2. Existing loan portfolios: Fixed-rate loans or long-term loans with fixed interest rates limit immediate transmission. 3. Asset-liability mismatch: Banks' assets (loans) and liabilities (deposits) have different interest rate sensitivities. However, in contrast, when policy rates rise, transmission is faster as - Banks quickly pass on higher rates to borrowers. - Depositors expect higher returns. #monetarypolicy #rbi #interestrates #transmission #banks #deposits #lending

Monetary Policy Transmission Channels 1. Interest Rate Channel: The transmission of monetary policy through interest rates has been less effective. The review highlights that while the impact on the short-term money market is immediate, the medium-term money market shows less responsiveness. Despite reductions in policy rates and the interest rate corridor's higher limit, the broader transmission to the credit market remains weak. 2. Lending Rates Channel: The effectiveness of monetary policy transmission through lending rates is limited. The readiness and health of the banking system significantly affect this channel. Issues within banks or their unwillingness to lend result in ineffective rate cuts, which fail to stimulate demand as intended. 3. Asset Price Channel: This channel is also noted to be ineffective. Despite lower interest rates, there has not been a significant increase in asset prices, such as real estate, due to subdued lending growth and low market confidence. 4. Exchange Rate Channel: The exchange rate channel has not been effective either. Lower domestic investment returns due to interest rate cuts have not led to substantial foreign capital inflows, impacting the domestic currency and trade balance. https://lnkd.in/ddjCnZH9

Our paper “The Housing Supply Channel of Monetary Policy” with Martin Iseringhausen and Frederic Opitz has finally been published in the International Journal of Central Banking! 🏡📈 In this paper we explore how monetary policy affects the housing market through housing supply. Using a FAVAR model, we find that this supply channel helps explain why U.S. states respond very differently to monetary policy shocks: states with tighter or more inelastic housing supply experience a stronger slowdown in economic activity and higher financial stability risks. We also uncover important shifts in housing tenure decisions: when monetary policy tightens, homeownership costs rise, house prices fall, and rent prices increase, pointing to a reallocation of demand from owning to renting. With central banks around the world currently debating potential rate hikes, these supply-side effects make understanding monetary transmission more timely than ever. You can read the full paper here 👇: https://lnkd.in/eWcBMDMe