Conventional price elasticity of demand is a simplistic and elementary formula that has mathematical and economic deficiencies when applied to price (rates) and demand (balances) of deposit products:
- It does not recognize inverse relations between price and demand.
- It assumes that rates and balances of deposits operate in a vacuum.
Economic deficiency – Conventional price elasticity measures the relations between interest rates and balances of deposits as if they are the only two factors impacting demand. That is never the case because the economic environment is always a factor. In other words, the economic environment can change the relations, so called “elasticity”, between price and balances even if the there has been no in the rate. Case in point. In the past two years, the national average rate of MM accounts stayed flat, while balances nationally grew by 12 percent. Was the increase in demand due to the rate? Not at all. It was solely the result of the economic environment, which impacted demand for MM accounts.
To overcome these deficiencies in the conventional price elasticity model, bankers should use the Relasticity method to determine the true impact rates have on demand for deposit accounts. Starting January, every Deposits Dynamics forecast will include Relasticity analysis of all major deposit accounts allowing bankers to make the right pricing decisions based on how truly relevant the rate is in shifting demand.