How the use of floating-rate loans changes the impact of monetary policy
Filippo Ippolito, Ali K. Ozdagli and Ander Perez add another dimension to the monetary policy transmission channels. This one adds floating rates to the discussion.
Most lending by banks to corporations occurs through loans with floating interest rates. As a result, conventional monetary policy actions are transmitted directly to borrowers via a change in the interest rate paid on existing bank loans. This column argues that the ‘pass-through’ of policy rates to the cost of outstanding bank loans has significant real effects for corporations.
How does the floating rate channel compare to the traditional bank lending channel? The academic literature estimates that a 1% rate hike generates an average $0.3 cash shortfall on a $100 dollar business loan through the bank lending channel. In comparison, the floating rate channel generates a $0.32-$0.88 cash shortfall under the same scenario, suggesting that the floating-rate channel is at least as important as the traditional bank lending channel.
The widespread use of floating-rate loans means that there is a direct pass-through of interest rates from monetary policy to the cost of debt of corporations. This fact bears non-trivial implications for how changes in monetary policy affect firm behaviour in the cross-section. The floating-rate channel appears to be a key element of what is known as the firm balance-sheet channel. The floating-rate channel is distinct from other channels studied in the literature because it operates through the cost of existing debt rather than on new debt.
Hmm..This floating rate is so obvious but still has been missed from literature…