Interest Rate Transmission in the UK : A Comparative Analysis Across Financial Firms and Products

This paper differentiates itself from the existing literature by testing for heterogeneities in the interest rate transmission mechanism using a large sample of 662 monthly retail rate histories (1993-2004) on seven key deposit and loan products. Error correction models are estimated to analyze long run pass-through, long-run mark up and the short run speed of adjustment. The prediction that the official and retail rates move together in the long run is supported by the data. The evidence suggests weak between-product heterogeneity but notable differences were found between financial firms in the way they adjust their rates which could hinder the achievement of monetary policy objectives. Consumer responses to official rate changes could therefore be more phased and intricate than hitherto believed. Heterogeneity in adjustment is found to be linked to menu costs and key financial ratios under managerial control