The Transmission Mechanism of Monetary Policy

Abstract

This study presents coverage of the transmission mechanism of monetary policy in the UK. It shows that historically, monetary policy has evolved through several distinct phases and frameworks over the last quarter of a century. A "new consensus" has emerged as a key theoretical construct of this process, with implications for the nature and role of money in an endogenous framework. It is argued that this is the essential basis for the current mode of economic analysis at the Bank of England. A further series of implications of this are the outcomes of Inflation Targeting as an objective of monetary policy. The stance can be shown to underpin thinking on monetary policy rules and these are used to perform an initial econometric analysis of a monetary policy reaction function. It is argued that the essential time series properties of such rules are generally overlooked in the empirical literature. Tentative analysis suggests that Taylor-type monetary policy reaction functions may not necessarily fit with an Inflation Targeting policy. In addition, the extent of pass through from official to retail bank interest rates is considered and shown to be incomplete.