Interest rate pass-through: a nonlinear vector error-correction approach

This paper analyzes pass-through from money market rates to consumer retail loan and deposit rates in Canada from 1983 to 2015 using a nonlinear vector error-correction model. This model permits estimation of long-run pass-through coefficients while simultaneously accounting for asymmetric adjustments and short-run dynamics. In contrast to empirical frameworks used in previous studies, it also allows testing of commonly made assumptions such as exogeneity of the market rate, making inference more robust. I find that pass-through was complete for all rates before the financial crisis although only after the mid 1990s for the 1 year mortgage rate. Since the end of the 2008-2009 recession, pass-through remains complete in the mortgage market but has significantly declined for deposit rates. Furthermore, many rates adjust asymmetrically but the direction of rigidity differs among rates and time periods.