Forward guidance and interest rate pass-through: evidence from New Zealand

Purpose This paper examines the impact of forward guidance in monetary policy on the pass-through of interest rates in New Zealand by analyzing the degree of both the long-term and short-term pass-through. Design/methodology/approach We use dynamic OLS to estimate the long-term relationship between the official cash rate and the time-deposit rates and various lending rates of New Zealand banks. We use a standard error correction model to estimate the short-term dynamics. Findings The results show that implementing forward guidance improves the degree of long-term pass-through, especially for time-deposit interest rates and longer-term fixed mortgage rates. Furthermore, the markup for various lending rates decreased, and the degree of short-term pass-through increased slightly after the implementation. Practical implications Implementing forward guidance enhances the transmission of monetary policy. Commercial banks are able to respond more quickly to changes in monetary policy by adjusting their deposit and loan rates. Originality/value New Zealand is the first country to mandate inflation targeting. Since its birth in 1990, the 2% inflation target has become the norm for central banks all over the world, including the FED, European Central Bank, Bank of Japan, Bank of England, etc. To our knowledge, ours is the first paper to examine the impact of forward guidance on the interest rate pass-through.