6.3 Monetary and interest rate policy Understand what is meant by interest rate policy. Understand how interest rate policy works to achieve a target rate of inflation. Evaluate the effects of interest rate policy on the economy.

Key terms Monetary policy – a policy aimed at affecting the total supply of money in the economy. Interest rate policy – the use of interest rates to try and achieve the governments economic objectives. Bank rate – the interest rate set by the Bank of England, which affects all interest rates in the economy (base rate)

WE MUST REFER BACK TO PAGE 52. IMPORTANT. The governments objectives. In order to achieve these objectives the government uses 3 different strategies; 1. Fiscal Policy 2. Monetary Policy 3. Supply side economics.

The effect of interest rates on the economy: Must imagine that people will either save or spend If interest rates go up: 1. More saving and less spending – Why? 2. Price of mortgages goes up, so less spending. If less spending it has a good effect on inflation as there is less pressure on prices. However bad for employment – downward mulitplyer.

Rates Base rate – the rate the BOE will lend to commercial banks. The BOE will need to lend to ensure commercial banks have liquidity. LIBOR rate- between banks Mortgage Personal loans Credit cards Store cards WONGA

MPC Main objective of interest rate policy – stable rate of inflation. Looking at roughly 2% per annum as measured by CPI. MPC sets interest rates in order to achieve target. As almost impossible to hit exactly 2% month on month- band of 1-3% is fine. Have to consider other aspects of economy including employment and economic growth. Meet once a month.

How does it work? What affects do the MPC expect? If MPC believes inflation will rise, it will raise interest rates to try and cut spending and thus less pressure on prices. Savings Borrowing for consumers Borrowing for firms Mortgage rates.