EconomyWhat to do if the transmission does not work?

What to do if the transmission does not work?

(Expansión) – Responding promptly to the question in the title of this column: if it’s about your car, taking it to the mechanic is the most advisable thing to do, but if it’s about monetary policy, that solution might not work.

It is important first to define what the transmission mechanisms of monetary policy are and we could define them as the means or channels through which changes in the reference interest rate affect other rates, credit, savings, prices of assets, agents’ expectations and, in general, in the real economy, but above all in inflation, which is our main concern at the moment.

Thus, it would be expected that, with the cycle of increases in the reference interest rate that began in mid-2021 in most central banks and with which they seek to cool demand, inflation will also moderate.

Notwithstanding this, at least in the case of the world’s largest economy, the United States, some indicators that measure the state of the economy still do not show the weakness and even recession expected by the most pessimistic, on the contrary, they have retained some resilience, while inflation remains stubbornly high.

These delays from monetary policy decisions to the real economy do not mean that the transmission mechanisms do not work, but rather that the economy takes some time to assimilate the decisions of the central banks. It depends on the conditions of each economy, but it can take between three months in the case of sectors with greater sensitivity to rates (eg housing), and up to eight months for the rest of the sectors, although there is always the possibility that those delays extend for longer.

The time that elapses between the monetary policy announcement and its first impact on the real economy may also vary according to the strength of the transmission mechanisms themselves.

There are usually two main transmission mechanisms or channels which (sinning of simplification) work as follows:

The first is the one that is born with the monetary policy instruments (interest rate, purchase of assets) and is connected with the financial conditions, which in turn are linked with the economic slack, which is the last step before reaching the sources of inflationary pressure (only those that can be influenced by monetary policy; an example of those that cannot, would be increases in the international price of energy and agricultural products).

The second channel is that of the expectations of economic agents, which basically consists of keeping inflation expectations low at different time intervals, since consumption and investment decisions (demand), and therefore on price levels, depend on largely fair to the inflation that prevails in the future.

Also, while these two are the most common channels, they are not the only ones. There are others related to the yield curve, the exchange rate, etc., and any shock in the foreign exchange or money markets could also hinder the transmission and generate more delays.

It is true that the high levels of inflation that prevail concern us all, although knowing all of the above, we can be certain that the decisions that have already been made since the increases in interest rates began will soon make a dent in the levels of prices, and what’s more, when that happens, our concerns will be different (spoiler: economic slowdown, weakness in the labor market).

Editor’s note: Ángel Huerta is an economic analyst at Grupo Financiero Bx+. He is an economist and apprentice mathematician. He likes tacos, classical music, and academic discussions on economic growth and social development. Tweet, then exist in . The opinions expressed in this column belong exclusively to the author.

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