What is the interest rate pass-through under surplus liquidity in the banking sector?

Tevdovski, Dragan and Hadzi-Velkova, Biljana (2025): What is the interest rate pass-through under surplus liquidity in the banking sector?

Abstract

This paper examines the interest rate pass-through in an economy with structurally high banking sector liquidity, using North Macedonia as a case study. Persistent surplus liquidity limits commercial banks’ reliance on central bank and interbank funding, potentially weakening the transmission of monetary policy. Employing a dynamic autoregressive distributed lag and error-correction (ARDL/ECM) framework augmented with a liquidity variable, we estimate the two stages of the transmission process - from the policy rate to the interbank rate, and from the interbank to lending rates. The results show that high liquidity dampens both the strength and speed of pass-through by reducing interbank rate responsiveness and moderating lending rate adjustments. These findings suggest that in banking systems with structural liquidity surpluses, conventional interest rate policy may be insufficient, underscoring the need for complementary instruments to enhance monetary transmission effectiveness.

• Item Type: MPRA Paper
• Language: English
• Keywords: interest rate, lending, liquidity, monetary policy, banking sector.
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O11 - Macroeconomic Analyses of Economic Development

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