Central banks of major advanced economies have maintained a very accommodative monetary policy stance in the last few years. However, concerns have surfaced that the transmission of low policy rates to lending rates has been weaker than in the past. Has the transmission of policy rates to lending rates been impaired by the global financial crisis? To answer this question, we first estimate standard cointegrating equations linking policy and lending rates for non-financial firms in Italy, Spain, the United Kingdom and the United States. We then test for structural change in the cointegration parameters, finding strong evidence of a break after Lehman Brothers' default. Such a structural break is owed to a strong increase in the mark-up of the lending rate over the policy rate that standard models assume constant in the long à The authors would like to thank Dietrich Domanski, Dubravko Mihaljek, Christian Upper and, in particular, two anonymous referees for their useful comments and suggestions. The views expressed are those of the authors and do not necessarily reflect those of the BIS.

After the global finance crisis, policy rates were cut to near-zero levels, yet, bank lending rates did not fall as much as the decline in policy rates would have suggested. If the crisis represents a structural break in the relationship between monetary policy and lending rates, how should central banks view the post-crisis transmission? This poses a major puzzle for monetary policymakers. Using a new weighted average cost of liabilities to measure banks' effective funding costs we show a model of interest rate pass-through with dynamic panel data methods solves this puzzle, and has many other advantages over traditional approaches. It confirms central banks should focus on the cost and composition of bank liabilities, as many are now doing, to better understand and steer the dynamics of lending rates.

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