Interest rates and the channels of monetary transmission: some sectoral estimates

The monetary transmission mechanism describes the channels through which changes in monetary policy affect the policy target, price inflation. Understanding the transmission mechanism is thus central to the successful conduct of monetary policy. This paper uses a Vector AutoRegressive (VAR) methodology to uncover a number of stylised features of the monetary transmission process in the UK. In particular, close attention is paid to the role played by money and credit as intermediate channels. The possibility that the transmission mechanism may differ across sectors is allowed for by estimating separate VARs for the personal and corporate sectors. Three policy conclusions emerge. First, as suggested by Classical Theory, monetary policy is output neutral over the longer term. Second, the lags between changes in monetary policy and its effect upon prices are lengthy (at least 18 months). And third, that aggregate measures of money and credit may provide blurred signals of the impact of monetary policy in final variables. Sectoral measures of bank deposits (for companies) and bank credit (for persons) provide the more timely intermediate indicators.