Policy Rate Pass-Through: Evidence From the Costa Rican Economy

Abstract

This paper examines the pass-through of the policy interest rate for the Costa Rican economy in the period 1996-2007. By estimating a non-linear asymmetric vector error correction model we found evidence supporting the hypothesis of a complete pass-through in the long run. Results also show that since the introduction of the administrated band exchange rate system (October 2006) banks react faster in the short run to movements of policy rate. Evidence does not favor the hypothesis that in the short run banks react differently to policy rate movements depending on whether such changes are positive or negative, in other words, there is no evidence of an asymmetric reaction of retail interest rates to movements of policy rate. On average, loan and deposit rates take 9.4 and 5 months respectively to fully pass a shock of policy rate. These average times are reduced to 3.5 and 2 towards the end of the sample. Private Banks pass a larger portion of any given movement of policy rate than State owned ones, but take more time to fully do so. Such results, by signaling a smoother transmission mechanism of the monetary policies, denote an encouraging environment to the process of migrating to an inflation targeting monetary regime.