DP20167 Banks and the State-Dependent Effects of Monetary Policy
We show that the response of banks' net interest margin (NIM) to monetary policy shocks is state dependent. Following a period of low (high) Federal Funds rates, a contractionary monetary policy shock leads to a significantly increase (decrease) in NIM. The response of aggregate economic activity exhibits a similar state dependent pattern. To explain these dynamics, we develop a banking model in which households’ attentiveness to deposit interest rates is influenced by social interactions. We embed this framework within a heterogeneous-agent NK model in which state-dependent responses in NIM to a monetary policy shock generate state-dependent responses in aggregate economic activity. Our estimated model accounts well quantitatively for our key empirical findings.
