Monetary policy💹 is the process by which the Bank of England or any other central bank sets the interest rate(currently 0.5% in the UK) and influence money supply through measures such as quantitative easing: The process at which the Government buys up financial assets in a bid to increase the supply of money and reduce interest rates in the economy – in order to reach a target rate of inflation. The current Uk inflation target rate is 2% and the current UK inflation rate is 2.4%
The UK Monetary policy committee meets 8 times a year to determine if the interest rates should change or remain the same.👨💼👨💼
Inflation is essentially the cost of goods rising faster than the value of money, this occurs when there is too much demand and spending in the economy. So e.g your £10 could buy you a loaf of bread in 2017 but now in 2018 the same £10 can't buy you a loaf of bread as bread now costs £11. In this case, prices rose and the value of your money did not rise in line with it.
Interest rates affect inflation by reducing or increasing our spending power as they affect our ability to borrow. If the cost of borrowing is cheaper then we are more likely to spend but if it is more expensive we are less likely to borrow and spend.
What tools does monetary policy have available:
To reduce interest rates:✔
the monetary policy committee can vote to buy or sell government securities( Government bonds). When the Government buys back the bonds it has issued this creates a huge spike in demand for those bonds which forces their prices to rise and make their yield(return) seem little. When this occurs investors will then push this demand to new bonds being issued by the private market but the private market has so much demand now for its bonds that interest rates fall as the banks and companies who issue these bonds have no reason to offer higher interest rates due to the huge demand.
To Increase interest rates & reduce inflation:✔
the Monetary policy committee will simply raise interest rates. These are the rates at which it lends to banks who in tend lend to consumers. If banks borrow the money at a higher cost they must then lend it to consumers at a much higher cost in order to make any returns.
This is how the Central bank affects interest rates.
The central bank and monetary policy committee might also be tasked with aiding other government objectives such as increasing economic growth
To increase economic growth:✔
the central bank will look to increase the money supply in an economy by purchasing assets such as government bonds, investing in new infrastructure such as roads, schools, hospitals etc.
In the case of bonds, the government buys enough bonds to push the demand curve higher and hence the price of bonds higher. This makes them seem unappealing to new investors and those who have just sold their bonds. This money consequently then flows towards more risky investments such as company stocks. This is good for the economy as companies now have more money to invest, create new jobs, make new tax payers and pay more tax itself.
By investing in new infrastructure the government increases the amount of employed people and the amount of disposable income in the economy which leads to greater spending from consumers.