T he article by Stein and Kashyap mirrors the operations and some possible effects of monetary policy in the US and other countries. However, two sets of modifications are required for any discussion of policy in the UK.
The first concerns the techniques used by the monetary authorities. In the US, as in France, Germany and Italy, banks (and in the US comparable depositary institutions) are subject to compulsory minimum reserve requirements in the form of non-interest- bearing balances with the central bank. In the UK this has not been the case since 1980, apart from an insignificant balance intended to meet some of the operating costs of the Bank of England.
This means that the discussion of policy operations in the US embraces the role of required’ reserves and the possible behavior of bank ‘excess’ reserves, those held above the minimum, in a way that is not today relevant to operations of both the central bank and the banks themselves in the UK. In the US it is possible to talk of monetary policy as operating, via the bank reserve mechanism, on both short-term interest rates and the supply of bank credit. (In most countries bank capital ratios may also constrain lending on occasions.)
Central bank control over money market rates in all countries derives from the fact that, whether or not compulsory reserve ratios exist, banks need balances with the central bank to meet their clearing and currency obligations. In the UK Bank of England operations affect economic activity through interest rates alone; here these influence the demand for, rather than the supply of, bank loans.
The main reason is that it is clear that the Bank of England has always been prepared to supply whatever level of primary reserves is required to support the level of bank deposits that results from the pattern of interest rates, the level of economic activity and the public’s asset-holding preferences. It is, of course, the Bank of England s ability to define the terms on which it is prepared to supply these reserves that gives it its power to determine short-term rates.
Even in countries with compulsory reserve requirements the situation is fundamentally the same in this respect; for failure to supply reserves — or, in some countries, to allow banks to obtain them through the foreign exchange market — would lead to intolerable fluctuations in short-term rates and possibly to bank collapse. But the enforcement of compulsory minimum reserve ratios does lead central banks to have an additional intermediate’ target — for bank reserves — which, in turn, leads
commercial banks to take this into account in framing their lending policies. This is not the case in the UK.
The second possible difference between conditions in the US and UK concerns the effects of monetary policy, its so-called ‘transmission mechanism’. Stein and Kashyap (but not all US economists) emphasize the liquidity effect on (particularly small) firms,
Unraveling the workings of monetary policy - a UK postscript
which may find it more difficult to obtain bank loans in a period of ‘tight’ monetary policy (as distinct from having to react to an increase in their price).
As it happens, until the 1970s, when UK bank lending could be constrained by the supply of required ‘secondary’ liquid assets, British monetary policy placed even more emphasis on credit supply effects. Indeed policy was always described officially as a ‘credit’ rather than a ‘money’ supply policy; and in the post-war period direct controls over bank lending were also in force from time to time. But over the years the rationale of policy has shifted to ‘money’ supply behavior, in which interest rates play a vital if not always predictable part, and finally more or less to interest rates alone as the most reliable determinant of economic activity and the level of inflation, at least in the short-run.
Business surveys have revealed little evidence of bank credit availability effects on the corporate sector in the UK, which is perhaps unsurprising in view of the increasing access even of relatively small firms to non-bank finance in domestic and euro markets.
It also needs to be said that monetary policy operates powerfully on the personal sector in the UK and perhaps more so than in the US. In Britain, where almost 70 per cent of households own their own homes, variable interest rate mortgages are overwhelmingly the rule, unlike the case in the US. Interest rate changes can thus have a powerful net effect on the finances of the household sector, even allowing for the opposite effect on savers, as well as on the wealth of both sets of households through the repercussions for house prices. In the US, where personal holdings of securities are relatively much larger, it is the wealth effect via the stock market that is more significant than in the UK. In addition, because foreign trade represents a much larger proportion of economic activity in the UK — exports of goods and services form 29 per cent of GDP at market prices in the UK but only 11 per cent in the US — the exchange rate effects of interest rate changes are also stronger than in the US.
Finally, when considering the possible differences in the transmission mechanism between countries, the question arises as to whether a unified monetary policy of a European Central Bank would have differential effects as between the member countries of the European Monetary Union. Their financial structures are still sufficiently diverse to make this a likelihood.
In this second article examining the links between the actions of monetary authorities and the spending decisions of individuals and businesses, Harold Rose highlights the particular factors that need to be taken into account when looking at the United Kingdom.
The first set of modifications result from differences in the techniques used by monetary authorities. In the UK, the Bank of England's operations affect economic activity largely via interest rates, with less emphasis on reserve requirements. Its operations work on the demand for bank loans rather than the supply. The second possible modification concerns the effects of monetary policy; its ‘transmission mechanism’. In the UK, changes in interest rates are shown to have a more powerful effect on both the personal financial sector and the prevailing exchange rates.
Suggested further reading
Boris, C.E.V., (1997), ‘The Implementation of Monetary Policy in Industrial Countries: A Survey’, Board for International Settlements, July.
Dale, S. and Haldane, A., (1993), ‘Bank behaviour and the monetary transmission mechanism’, Bank of England Quarterly Bulletin , November.