monetary policy

Monetary Policy

The control of interest rates and money supply by the central bank to influence the economy

Interest Rate

The cost of borrowing money or the reward for saving

Bank Rate

The official interest rate set by the Bank of England

Monetary Policy Committee (MPC)

A group of nine members at the Bank of England who set monetary policy and the Bank Rate

Inflation Target

The UK aims for 2 percent inflation measured by CPI

Expansionary Monetary Policy

A reduction in interest rates to increase borrowing, spending, and aggregate demand

Contractionary Monetary Policy

An increase in interest rates to reduce borrowing, spending, and inflation

Interest Rates and Consumption

Lower interest rates reduce the cost of borrowing, which increases household spending

Interest Rates and Saving

Higher interest rates increase the reward for saving, which may reduce consumption

Interest Rates and Investment

Lower interest rates reduce borrowing costs, which encourages firms to invest

Interest Rates and Exchange Rate

Higher interest rates attract foreign investment, which may increase the value of the pound

Interest Rates and Inflation

Higher interest rates reduce aggregate demand, which helps control inflation

Interest Rates and Economic Growth

Lower interest rates increase spending and investment, which can increase economic growth

Transmission Mechanism

The process through which changes in interest rates affect consumption, investment, exchange rates, and inflation

Time Lag

It can take up to two years for interest rate changes to fully affect the economy

Evaluation: Consumer Confidence

If households and firms lack confidence, they may not increase borrowing even when interest rates fall

Evaluation: Output Gap

Interest rate cuts are more effective when there is spare capacity in the economy

Evaluation: Policy Conflict

Policies that increase growth may also increase inflatio