Explaining interest rate differentials
In this NBER working paper, Marvin Goodfriend and Bennett T. McCallum, suggest that a central bank that fails to recognise the distinction between inter-bank and other short rates could miss its appropriate settings by as much as 4% per year.
The authors also argue that shocks to banking productivity or collateral effectiveness call for large responses in the policy rate.
To examine these issues, they use an optimising model which specifically includes the banking sector and monetary developments. The model is implemented quantitatively, with a calibration based on US data.
The authors suggest that their model is "reasonably successful in providing an endogenous explanation for substantial steady-state differentials between the interbank policy rate and (i) the collateralized loan rate, (ii) the uncollateralized loan rate, (iii) the T-bill rate, (iv) the net marginal product of capital, and (v) a pure intertemporal rate."
To download this paper, visit the NBER webpage.
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