Revision: Monetary Policy Asymmetry

Changes in interest rates do not have a uniform impact on the economy. Some industries and businesses are more affected by interest rate changes than others for example exporters and industries connected to the housing market. And, some regions of the British economy are also more sensitive to a change in the direction of interest rates.

The markets that are most affected by changes in interest rates are those where demand is interest elastic in other words, demand responds elastically to a change in interest rates or indirectly through changes in the exchange rate.

Good examples of interest-sensitive industries include those directly linked to demand conditions in the housing market¸ exporters of manufactured goods, the construction industry and leisure services. In contrast, the demand for basic foods and utilities is less affected by short term fluctuations in interest rates and is affected more by changes in commodity prices such as oil and gas. Contrast the effect of a housing recession on a business such a brick manufacturer with the impact on Tesco.

Monetary policy asymmetry is also important for countries that have decided to enter the Euro Area and share a common currency - the Euro. Decisions taken by the European Central Bank are made with a view to maintaining price stability for the Euro Area as a whole - an area covering sixteen countries, many of which are very different in terms of their economic structure. Thus it becomes difficult for one official short term interest rate to be anything like optimal for all countries. Spain and Ireland are different from Germany and Austria.

Keep in mind too that the official ‘policy’ rate of interest is under the control of the Bank of England, but most other economic variables are not! The MPC’s decisions can influence consumer and business behaviour but it cannot determine directly the rate of inflation. Ultimately it is businesses that set the prices we pay rather than the Governor of the Bank of England and his Monetary Policy Committee!

Macro-policies that seek to raise the level of aggregate demand and output are called “accommodatory policies”. In other words, they boost demand beyond what would normally happen through the working of the automatic stabilisers. A good example of this is the decision by the Bank of England to cut policy rates from 5% to 0.5% in the space of less than a year. And the UK government’s decision to increase the size of their cyclically adjusted budget deficit.