I study how the secular decline in interest rates affects bank lending and intermediation spreads. A fall in rates stimulates lending in the short run, but if the rate decline persists, lending contracts in the long run. Even when rates are well above the zero lower bound, lower rates compress deposit spreads due to the competition between money and deposits. This hurts retained earnings, equity, and ultimately lending, until loan spreads have risen enough to offset the reduction in deposit spreads and stabilize bank net interest income. A departure from the Friedman rule in the form of a higher inflation target can support bank lending at the cost of higher liquidity premia. I find support for the model’s predictions in U.S. aggregate and cross-sectional data.
JEL Classification: E4, E5, G2
Suggested Citation: Suggested Citation
Wang, Olivier, Banks, Low Interest Rates, and Monetary Policy Transmission (December 30, 2018). Journal of Finance, forthcoming, Available at SSRN: https://ssrn.com/abstract=3520134 or http://dx.doi.org/10.2139/ssrn.3520134
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