Is the Transmission Mechanism worth calculating? http://morganisteconomics.blogspot.com/2011/02/is-transmission-mechanism-worth.html The Transmission Mechanism, according to the Bank of England, âThe Monetary Policy Committee (MPC) sets the short-term interest rate at which the Bank of England deals with the money markets. Decisions about that official interest rate affect economic activity and inflation through several channels, which are known collectively as the âtransmission mechanismâ of monetary policy.â (link) However I would like to go a bit further and isolate a specific function or view of the Transmission Mechanism, which I believe is completely futile. The effect of an interest rate alteration is monitored and predicted for two years. The concept that a small alteration in the short term interest rate can have a huge effect on the long term economy is in my opinion impossible to predict accurately. Further than that there are so many other factors that impact the economy especially on an international level, such as oil prices and foreign currency alterations, that the effect of an interest rate alteration is unlikely to have a significant impact on the level of demand up to two years after it was enacted. Any impact that it does have is likely to be counteracted or dwarfed by these other factors. I also have my reservations about the calculation of the Transmission Mechanism in general. The functions and predictions of the impact of the actions the Transmission Mechanism creates are supposed to relate to the rate of inflation, partly through controlling aggregate demand and partly through predicting future inflation. This leads to the issue that bothers me the most, inflation is not calculated by weighing aggregate demand against aggregate supply but through the relative increase or decrease in a basket of goods over a period of time. Although it is likely that an alteration in money supply could lead to an increase or decrease in the prices for the basket of goods it does not guarantee it. Remember it is also only a measure of monetary effects of the economy, which could lead to an inflationary or deflationary gap and although this is the current popular view of the creation of inflation it does not support the concept of the original inflation calculation through the increase in the price of a basket of goods. There is another aspect relating to supply of goods which impacts on prices so the calculation of money supply alone cannot in my opinion provide a fully accurate prediction of future prices. Perhaps I am Keynesian leaning in this view but I think I have a justifiable point. The international aspect of supply from foreign trade partners will have an impact on the future price of goods as much if not more than the domestic monetary targets. I do not think it would be possible to go to each country we trade with and calculate future supply prices and even I did I would not advise it. I personally believe that inflation should be dealt with when it occurs and that the actions used should be direct and short term. The measurement of the impact of that action should not be estimated to predict what the rate of inflation will be in two years time, it should be purely to impact the current prices of the basket of goods.