Improving the Design and Effectiveness of Monetary Policy
Submitting InstitutionUniversity of Nottingham
Unit of AssessmentEconomics and Econometrics
Summary Impact TypeEconomic
Research Subject Area(s)
Economics: Applied Economics, Econometrics
Commerce, Management, Tourism and Services: Banking, Finance and Investment
Summary of the impact
Research by the School's Centre for Finance, Credit and
Macroeconomics (CFCM) on the monetary transmission mechanism has
been influential in improving the design, implementation and effectiveness
of the monetary policies of a number of central banks, including the Bank
of England, Banque de France and the European Central Bank.
The research has influenced changes in the way that official monetary
aggregates are measured so as to capture the impact of non-bank financial
institutions on the money supply and credit availability, and in better
understanding of how monetary policy affects different interest rates.
This in turn has allowed for improved control by central banks of their
policy targets, and for better understanding of the effects of their
monetary policies on economic activity and inflation.
CFCM brings together the work of researchers working in the School
on financial markets, macroeconomic cycles, and consumer and corporate
credit. In this case study the focus is on CFCM's research on the
monetary transmission mechanism (MTM). Paul Mizen (then Reader in
Monetary Economics, University of Nottingham) was recruited as a
consultant (40% contract) to undertake research at the Bank of England
between 1997 and 2000 to assist the Monetary Policy Committee (MPC)
in understanding: a) the importance of money and credit for the MTM,
particularly output and inflation; b) the different impacts of household,
non- financial firms and non-bank financial firms' money and credit on
output and inflation; and c) the pass through of interest rate changes to
households and firms through the banking system.
Mizen had been approached to join the Monetary Assessment and
Strategy Division headed by Paul Tucker (subsequently a Deputy
Governor of the Bank) after having published the book Buffer Stock
Models and the Demand for Money in 1994 and a number of refereed
papers on demand for money by UK households and firms. The
research undertaken subsequently was published in the Bank of England
working papers numbers 100, 134, 151, 170, and 254, summarised in the Bank
of England Quarterly Bulletin and also published in peer reviewed
journals (listed  -  below).
• Research insights and findings
The studies on money and credit, , ,  and  show that excess
money and credit held by households and private non-financial corporations
in the UK economy interact with each other and feed through to output and
inflation via the conventional monetary transmission mechanism. The
majority of excess money and credit is held by the non-bank financial
sector (insurers, pension funds, securities dealers, leasing companies
etc), and these balances have an indirect effect on monetary transmission
through their impact on households and firms. For example, money and
credit held by financial companies involved in factoring or leasing of
capital equipment directly influences output and inflation. Paper 
demonstrated that their balances have an impact on firms and household
The MPC is therefore right to be concerned about excess money and
credit held by these sectors and should be embedded in the Bank's
forecasting models. The Bank's own research in 2012 built on this sectoral
information following the work that was done by Mizen to improve
structural VAR forecasting models under Quantitative Easing (QE).
However, the non-bank financial sector is diverse, and some institutions
which are more like banks do not affect output or inflation — they should
be netted out. The monetary statistics collected by the Bank have
since 2009 netted out money held by both banks and the non-bank financial
sector that are similar to banks.
The study of interest rate pass through demonstrates that retail interest
rates set by banks (such as deposit, loan and mortgage rates) could
deviate from official rates set by the Bank of England in the
short run. This deviation is driven by expectations about the direction of
changes to official rates in the future. Paper  estimates the long run
relationships between different retail rates and the official rate using
individual bank data for the UK.
The absence of adjustment to retail rates in the short run, following an
adjustment to official rates, is not a cause for concern, since it may
reflect expectations by banks that adjustments are temporary, or likely to
be reversed. This research helped to explain why interest rates set by
banks do not follow official rates set by central banks at turning points.
It also answered a concern expressed by journalists and other commentators
that changes to interest rates were not being passed on to commercial
banks' mortgage customers, by explaining more accurately how and when
banks respond to monetary policy changes.
• Key researcher
Paul Mizen, Lecturer (1992-99), Reader (1999-2004) and Professor
of Monetary Economics (2004-present), University of Nottingham.
References to the research
. Brigden, A. and Mizen, P. (2004) `Interactions between
Money, Lending and Investment in the UK Private Non-Financial Corporate
Sector', Manchester School, 72(1), pp. 72-99, January 2004; also
Bank of England Working Paper, No. 100, September 1999. [doi:
. Chrystal, A. and Mizen, P. (2005a) `Other Financial
Corporations: Cinderella or Ugly Sister of Empirical Monetary Economics',
International Journal of Finance and Economics 10, 63-80, February
2005; Bank of England Working Paper, No. 151, December 2001. [doi:
. Chrystal, A. and Mizen, P. (2005b) `A Dynamic Model of
Money, Credit and Consumption for the Household Sector' Journal of
Money, Credit, and Banking, 37, pp. 119-144, February 2005; also
Bank of England Working Paper, No. 134, May 2001. [stable URL: http://www.jstor.org/stable/3838939]
. Hofmann, B. and Mizen, P. (2004) `Interest Rate Pass Through
in the Monetary Transmission Mechanism: UK Banks' and Building
Societies' Retail Rates' [with Boris Hofmann] Economica, 71, pp.
99-125, February 2004; also Bank of England Working Paper, No. 170,
December 2002. [doi: 10.1111/j.0013-0427.2004.00359.x]
Details of the impact
The research listed  -  above underpins the Bank of England's
current research: Bridges and Thomas (2012) state:
"The PNFC sector model uses a three-equation system of PNFC money
holdings, borrowing and investment based on Brigden and Mizen (2004)"...
"Although aggregate models are useful, as they allow us to look at the
complete macroeconomic response to a QE shock, the linkages between
money, asset prices and spending have tended to be clearer at the
sectoral level in the UK data (see ... Brigden and Mizen (2004),
Chrystal and Mizen (2005a,b),)."
Prior to these studies the Bank of England was uncertain whether
excess money and credit balances held by non-bank financial corporations
should be treated like assets and liabilities held by banks (as they are
in the United States) which are netted out of the official figures, or
included in the analysis of monetary policy. The Bank now considers these
data from some of these institutions to be important for output and
inflation and factors them into its analysis. Prior to this research the MPC
could have understated growth in money and credit aggregates by ignoring
all non-bank financial institutions, some of which have an impact on real
activity and inflation. The Bank produces monthly reports on monetary
developments in these sectors (see [A] various issues), and discusses them
in the quarterly Inflation Report. It has cited research on money
and credit, including the research in this case study, as one of its major
contributions to understanding monetary transmission in the 50th
Anniversary edition of the Quarterly Bulletin, [C]. The main
beneficiary has been the Bank of England, and other central banks
that they influence.
The research has had an impact on official monetary aggregates published
by the Bank of England. The research provided the starting point
for a review of other financial institutions in the monetary statistics
taken up by Spencer Dale when he was Head of Division in
Monetary Assessment and Strategy. The Bank undertook to review its
monetary statistics [G] and after public consultation adjusted its measure
of broad money from M4 (deposits held by banks and building societies) to
M4X (M4 minus holdings of money by certain bank-like entities known as
intermediate other financial institutions). Since June 2009, the M4X
statistics have been produced monthly by the Bank. The decision to exclude
non-bank financial institutions that undertake similar activities to banks
e.g. bank holding companies, but to include financial institutions that
serve firms and households (e.g. leasing companies) recognises the
research that showed some financial institutions have an impact on output
and inflation. The beneficiaries are all users of monetary aggregates
produced by the Bank of England in the United Kingdom,
such as commercial and investment banks, insurance companies and pension
funds, private non-financial corporations and individuals.
This work on non-bank financial institutions involved Mizen in an
`Expert meeting on monetary analysis' in DG-Economics, European
Central Bank in 2006, which discussed the construction of monetary
aggregates excluding other financial institutions in Europe, [B].
It underpins the analysis of the recent weakness of broad money growth,
[D], and the assessment of quantitative easing in the UK, [E].
The research also contributes to our understanding of policy and
contributes to the public policy debate, particularly during times of
change when new instruments or objectives have been adopted for
extraordinary times e.g. quantitative easing policies. It is notable that,
while central banks had relegated information on monetary aggregates
during the mid-2000s and when inflation targeting appeared to be very
successful, they refocused on these aggregates with the introduction of
quantitative easing. At the Bank of England the understanding of
monetary aggregates and credit have primary importance with the
introduction of QE in March 2009, as [D], [E] and [F] document.
The Deputy Governor of the Bank of England wrote
`"The financial crisis has reminded economists of the centrality of
money and banking to macroeconomic conditions. At the Bank of England,
we drew on Paul Mizen's money models as a guide to gauging the
prospective impact of the Monetary Policy Committee's quantitative
easing on spending and asset prices."
One measure of the success of quantitative easing is the impact on bank
lending to UK businesses, which is reported by the Bank of England
monthly. The discussion in [H] shows how the measure of money excluding
certain non-bank financial corporations has an impact on the debate over
quantitative easing, as does [F]. The Editor of The Sunday
`The research has had a clear impact on the Bank of England, both in
its modelling and in construction of the monetary aggregates (the new
M4X measure). It has also informed the work of other central banks...and
the researchers have been used as experts by these central banks and
invited to undertake further work.'
The work on interest rate pass through has helped central banks to
understand how their policy decisions affect interest rates offered to
households and firms. This has become a very important issue in
understanding the monetary transmission mechanism. Mizen was
invited to the Bundesbank in 2005-6 to explore the effects of
interest rate pass through in Europe. This then led to an invitation to an
`Expert meeting on interest rate pass-through', at DG-Economics and
DG-Statistics, European Central Bank in 2007 to discuss transmission
of monetary policy http://www.ecb.int/events/conferences/html/mir.en.html.
The Banque de France invited further work on pass-through in the
major European economies and on individual French banks in particular in
2011. This work has been published as Banque de France Working Paper
N 361, and Journal of Money, Credit and Banking, 45, 1377-1417, October
2013. The findings were used by the Banque de France to establish
data and modelling protocols, forecasting assessment criteria, and
informed the European Central Bank through the Expert Group on
Financial Assumptions (EGFA) from April 2011-June 2013. The senior Banque
de France official responsible for this research writes:
`The research on interest pass through was very innovative and
extremely useful for the monetary policy decision making process: it
confirmed the importance of future expected interest rates in aggregate
euroarea data, and then verified this in data for individual French
commercial banks. It had a great impact on our understanding of this
aspect of the monetary transmission mechanism in the Banque de France'
Further work is being undertaken on individual bank pass through using
panel data in 2013. On 15th February 2013 Mizen
participated in a policy briefing on pass through and the Bank's Funding
for Lending Scheme with the Chief Economist of the Bank of England,
Spencer Dale, and his staff. In February 2013 Mizen was
asked to collaborate with Dr Garry Young (Bank of England) to
update and improve their model of pass through, this work is ongoing. Mizen
has also been invited by the Bank for International Settlements to
engage in a detailed study of pass through for advanced and emerging
economies in 2014. The major beneficiaries are central banks, especially
the Bank of England, the Banque de France and the European
Sources to corroborate the impact
[A] Bank of England Sectoral Breakdown of Aggregate M4 and M4
lending various issues http://www.bankofengland.co.uk/statistics/Pages/fm4/2012/aug/default.aspx
[B] Moutot, P. (2007) `The Role of Other Financial Intermediaries in
Monetary and Credit Developments in the Euro Area' ECB Occasional
Paper No. 75.
[C] Bank of England Quarterly Bulletin (2010) 50th Anniversary
edition, 50(4). Bank of England.
[D] Bridges, A., Rossiter, M. and R. Thomas (2011) `Understanding the
recent weakness in broad money growth', Bank of England Quarterly
Bulletin 2011 Q1, 51(1), 22-35.
[E] Bridges, A. and R. Thomas (2012) `The impact of QE on the UK economy
— some supportive monetarist arithmetic' Bank of England Working Paper
[F] Butt, N.,S. Domit, M. McLeavy and R. Thomas (2012) What can the money
data tell us about the impact of QE? Bank of England Quarterly
Bulletin 2012 Q4, 52(4), 321-331.
[G] Burgess, S. and N. Janssen (2007) `Proposals to modify the
measurement of broad money in the United Kingdom: a user consultation' Bank
of England Quarterly Bulletin 2007Q3, 402-413.
[H] Smith, D.B. (2012) `Money still matters: The Implications of M4X for
quantitative easing' IEA Discussion Paper No. 26, Institute for Economic
Individuals who could be contacted:
[I] Director of Research at the Prudential Supervision Authority,
[J] Manager, Monetary Assessment and Strategy, Bank of England.
[K] Deputy Governor, Bank of England.