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.View the Full Working Paper
The Reversal Interest Rate
WP 22-28 – We propose that the effective lower bound on monetary policy is the reversal interest rate, below which further rate cuts reduce bank lending. Our model demonstrates that this rate exists and estimates it is roughly -1% for the Euro area.