Interest rate pass-through in Pakistan: Evidence from transfer function approach

Abstract

This paper empirically investigates the pass-through of the changes in the interest rate on Treasury bills in Pakistan to money market rate (call money rate), banks' deposit rate, and banks' lending rate. The motivation for the study is that the effectiveness of the monetary policy transmission mechanism hinges upon the speed and extent of the pass-through of the policy rate to the individual elements of the transmission mechanism. Call money rate, banks' deposit rate, and banks' lending rate, being important elements of the monetary transmission mechanism, the examination of the pass-through to these rates will shed light on the effectiveness of the monetary transmission mechanism. The results are, by and large, in conformity with the literature on the pass-through: pass-through of the changes in the treasury bill rate to call money is completed in the impact period, i.e., one month. The pass-through to savings deposit rate starts during the first six months and continues for quite long. In the case of six-months deposit rate and the lending rate, no pass-through is noticed during the first six-months. The pass-through occurs between 1.5-3 years in both the cases.