Monetary policy and financial liberalization: The case of United Kingdom consumption

This paper outlines work done recently to investigate the impact of financial liberalization on monetary policy effectiveness. We look at the case of United Kingdom consumption behavior, in particular the savings ratio. Over the 1990s this sector has been heavily influenced by comprehensive deregulation of the U.K. financial sen;ices industry which has caused stable long-run relationships for the U.K, consumption function to shift significantly. We analyze the relationship between financial liberalization and consumption by evaluating and extending a forward-looking model in which the degree of financial deregulation influences the behavior of two groups of consumers: those constrained to consume from current income only and those able to borrow on the basis of expected future income flows. We show that specifications incorporating such features capture recent U.K. behavior reasonably well and pick up the main shifts in the savings ratio. We also show that changes in the extent of financial regulation cause the transmission of monetary policy to alter in important ways which have implications for the way in which monetary policy should be implemented.