1. Monetary Policy
A demand-side policy – shifts AD (secondarily affects AS)
1. Changes in short-term interest rates to influence the level of AD & inflation
2. Quantitative Easing (QE)

2. Economic Effects of Interest Rate Changes
Exchange Rate
Housing Market
Credit Demand
Interest rate changes will impact:
Investment
Saving

3. Monetary Policy Committee
MPC has 9 members
Governor plus 4 from the Bank of England (including 2 Deputy Governors)
4 external members appointed by the Chancellor
The MPC set interest rates every month in order to meet their mandate from the chancellor of the exchequer:
“inflation must be at 2%” (if inflation is below 1% or above 3%, the MPC must explain why in an open letter to the Chancellor)
Economic data is considered to assess the potential of each indicator to impact inflation

4. What do the MPC look at when deciding if inflation might become too high / too low…
Exchange Rate
Rate of GDP Growth
Wage Inflation
Housing Market
Credit Demand
Economic data
for consideration
Unemployment
Manufacturing Output
Investment
Retail Sales
MPC must consider all these things in the economy to assess the inflationary pressure that is likely – decide whether they need to change interest rates to achieve 2% inflation target.

5. How it will affect inflationary expectations… Investment
Economic indicator
How it will affect inflationary expectations…
Investment
If it is rising, then this will increase AD in the short run, causing Demand-Pull inflation. (In the longer term, it might lower production costs through greater efficiency reducing inflation again if AS shifts out)
If it is falling then…
Unemployment
If it is rising, then…
Housing Market
Rate of GDP Growth
If it is high, then…
If it is low then…
Exchange Rate
Wage Inflation
Credit Demand
Manufacturing Output
Retail Sales

6. Advantages of Lower Interest Rates
Cheaper for businesses to finance capital investment - long-run economic growth
Households enjoy cheaper loans for homes, cars, etc – boost to C
Easier to start new businesses – source of long-run growth
Reduced interest burden on the national debt for the Government - reallocate spending
Currency may fall

7. Disadvantages of Lower Interest Rates
Disincentive to save – (savings needed to finance investment, education, etc)
Retirees may see incomes fall
Credit boom may fuel rising inflation
Currency may fall

8. Quantitative Easing
Used when interest rates are already low and AD still needs stimulating
Bank of England creates new money electronically
B of E buys bonds from financial institutions (eg. pension funds, commercial banks)
Commercial banks have more cash to lend out to customers
↑ money available for lending → ↓ interest rates → ↑C & I → ↑AD

10. Criticisms of Monetary Policy
Difficult to assess state of the economy based on monthly data
Time lags – takes up to two years for effects to be fully realised in the economy
Effects on currency may be undesirable
One size fits all – needs of one sector may be opposite to those of another – can’t be targeted at problem areas
May not be effective if already anticipated