How the Removal of Deposit Rate Ceilings Has Changed Monetary Transmission in the US: Theory and Evidence

Abstract

Establishing the existence and nature of changes in the conduct and transmission of monetary policy is key in understanding the remarkable macroeconomic performance of the US since the mid 1980s. This paper presents evidence on a phenomenon of disintermediation occurring during the major recessions in the 1960s and 1970s, but absent ever since. Using a novel data set, I show that disintermediation is closely linked to the existence of deposit rate ceilings under regulation Q. In a monetary DSGE model that incorporates deposit rate ceilings as occasionally binding constraints, the regulation alters the behavior of money aggregates and exacerbates the drop in economic activity following a monetary tightening. The results of a time-varying coe±cient VAR lend support to the main theoretical predictions of the model. In a counterfactual experiment, the presence of deposit rate ceilings explains two thirds of the decline in output volatility since the early 1980s.