The Reversal Interest Rate
Abstract: The reversal interest rate is the rate at which accommodative monetary policy reverses and becomes contractionary for lending. We theoretically demonstrate its existence in a macroeconomic model featuring imperfectly competitive banks that face financial frictions. When interest rates are cut too low, further monetary stimulus cuts into banks’ profit margins, depressing their net worth and curtailing their credit supply. Similarly, when interest rates are low for too long, the persistent drag on bank profitability eventually outweighs banks’ initial capital gains, also stifling credit supply. We quantify the importance of this mechanism within a calibrated New Keynesian model.
File(s): File format is text/html https://www.philadelphiafed.org/-/media/frbp/assets/working-papers/2022/wp22-28.pdf
Provider: Federal Reserve Bank of Philadelphia
Part of Series: Working Papers
Publication Date: 2022-09-01