Competition among banks and the pass-through of monetary policy

Abstract

Empirically, stiffer competition among commercial banks implies that (i) loan rates and deposit rates correlate more tightly with the policy rate, (ii) loan rates exceed the policy rate less, and (iii) deposit rates undercut the policy rate more. I find that a New Keynesian model with monopolistically competitive banks can account for the first two of these empirical facts. The model predicts that increased competition in the banking sector reduces the spread between the steady-state policy rate and the loan rate. Furthermore, augmented competition among banks amplifies the pass-through of monetary policy to the real economy.