The interest rate transmission mechanism in the United Kingdom and overseas

Quarterly Bulletin 1990 Q2
Published on 01 June 1990

Financial deregulation and innovation have been features of many industrialised economies since the late 1970s; the completion of the EC single market and the prospect of an agreement in the Uruguay round of GATT negotiations to liberalise trade in financial services mean that the process of global deregulation is likely to continue. Concern has been expressed that this process of deregulation and innovation may have weakened the mechanisms through which changes in monetary policy-meaning here interest rates (usually short-term) controlled by national monetary authorities-affect aggregate demand and inflation. Any such changes would have important implications for policy since the governments of the major economies including the United Kingdom are committed to the use of monetary policy in pursuing price stability as a condition for stable and sustained growth.

After a brief general consideration of how interest rates might be expected to affect an economy, the first half of this article summarises current understanding of the ways in which interest rates affect the UK economy. It suggests that, contrary to the concerns noted above, the impact of interest rates on expenditure in the United Kingdom is now more powerful than in the past, and the channels of influence are more clearly discernible. The second half of the article examines some relevant features of the major overseas economies. The broad conclusion which emerges is that although there is some evidence of change in the early 1980s, data on asset and liability stocks and flows suggest little firm evidence of any radical change in the way that monetary policy influences the components of aggregate demand in these economies.

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