The Reversal Interest Rate

Markus K. Brunnermeier; Yann Koby

doi:10.3386/w25406

The Reversal Interest Rate

Markus K. Brunnermeier & Yann Koby

Working Paper 25406

DOI 10.3386/w25406

Issue Date December 2018

The “reversal interest rate” is the rate at which accommodative monetary policy reverses its intended effect and becomes contractionary for lending. It occurs when banks' asset revaluation from duration mismatch is more than offset by decreases in net interest income on new business, lowering banks' net worth and tightening their capital constraints. The determinants of the reversal interest rate are 1) banks' fixed-income holdings, 2) the strictness of capital constraints, 3) the degree of pass-through to deposit rates, and 4) the initial capitalization of banks. Furthermore, quantitative easing increases the reversal interest rate and should only be employed after interest rate cuts are exhausted. Over time the reversal interest rate creeps up since asset revaluation fades out as fixed-income holdings mature while net interest income stays low. We calibrate a New Keynesian model that embeds our banking frictions and show that the economics behind the reversal interest rate carry through general equilibrium.

We are grateful for comments by Joseph Abadi, Julien Bengui, Emmanuel Farhi, Lunyang Huang, Florian Heider, Sam Langfield, Cesaire Meh, Helene Rey, Philipp Schnabl, Frank Smets, Adi Sundaram, Skander Van den Heuvel, and seminar participants at the European Central Bank, the Bank for International Settlements, Princeton University, the Federal Reserve Board, Banque de France, the Danish Central Bank, the Finnish Central Bank, the London School of Economics, ETH Zurich, the Swiss Economists Abroad meetings, the Swiss National Bank, the 2018 AEA meetings, Humboldt University, the Philadelphia Macro Workshop, the International Research Forum on Monetary Policy, the University of Chicago, and the Bank of Canada. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.

Markus K. Brunnermeier
Disclosures 2015-

As a guiding principle I follow the NBER Research Disclosure Policy: http://www.nber.org/researchdisclosurepolicy.html

To date, no single relationship (other than my salary form Princeton University) has accounted for more than 15 percent of my aggregate annual income in that year.

Significant Remunerated Activities:
Speaking engagements and lectures

IMF

Luohan Academy/Alibaba

Central banks
ECB, NUS/Monetary Authority of Singapore, ESRB, Bundesbank (Research Council), Bank of Korea (Keynote presentation), Bank of England, National Bank of Austria, Swiss National Bank, Bank of Japan, Federal Reserve, New York Fed, Bank of Canada, Bank of Chile, Bank of Korea

Academic Organizations

Swiss Finance Institute, 2012-

No expert testimony for law suits or paid consulting work for private cooperation to date.

Research Grants:
Sloan Foundation 2011-12
Guggenheim Fellowship, 2010-11
INQUIRE Europe, Research Grant

Significant Non-Compensated Activities:
American Finance Association: Director
Financial Advisory Roundtable and Monetary Policy Panel, Federal Reserve Bank of New York, 2006 – present
INET Advisory Board Member, 2009 – present

Yann Koby
I acknowledge support from the Macro Financial Modeling Project at the Becker Friedman Institute.
MARC RIS BibTeΧ

The Reversal Interest Rate

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