RDP 9008: Financial Deregulation and the Monetary Transmission Mechanism 5. Summary and Conclusions

The aim of this paper has been to investigate how deregulation has affected the relationships between financial variables and the real economy. Our evidence points to the following conclusions:

1. the deregulation of the financial system has made very little difference to the reduced form relationships between interest rates, employment growth, inflation and the growth rate of real credit;
2. interest rates are an important determinant of both real activity and inflation;
3. the growth rate of real credit, on the other hand, does not appear to play much of a role in driving the business cycle. The effects of unexpected credit growth on real activity are more than offset by the resultant tightening of monetary policy. Credit growth responds positively to positive shocks to real activity but, again, this effect is more than offset by the interest rate effect;
4. the reaction of monetary policy is primarily to real variables, viz., the growth rates of employment and real credit. By contrast, the reaction of monetary policy to unexpected inflation was weak pre-deregulation and has since become virtually non-existent.