The Weakened Transmission of Monetary Policy to Consumer Loan Rates

Abstract

The economic recovery following the financial crisis and Great Recession of 2007-09 has been slow. Research has shown that recessions following banking crises are typically accompanied by large and persistent declines in output. Contributing factors include sharp declines in asset prices, such as housing prices, that damage the balance sheets of both households and financial institutions. These factors, combined often with a buildup of debt during the bubble years prior to a crisis, cause debt deleveraging to be drawn out. Demand for new credit by households is therefore depressed by the effects of reduced income and wealth, and by the debt overhang. Likewise, the supply of new credit from banks is limited by past liquidity and sol-vency shocks and by banks ’ perceptions of higher risk in future lending. The Federal Reserve has taken steps since the financial crisis to push both short- and long-term interest rates to historically low levels. These steps have aimed to reduce financing costs generally and, more specifi-cally, to lower the interest rates charged to finance consumer spending, which accounts for about 70 percent of all spending in the economy. However, interest rates charged by lenders to consumers do not change automatically when the Federal Reserve alters the stance of monetary policy. The extent to which policy actions pass through to consumer interest rates determines, in part, the effectiveness of Nada Mora is a senior economist at the Federal Reserve Bank of Kansas City.This article is on the bank’s website at www.KansasCityFed.org.

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