Monetary Policy

Monetary policy refers to any action taken by the Bank of England, on behalf of the Government, to try to influence either the supply of money or the Price of money, as given by the rate of interest.

Monetary Policys uses: Monetary Policy involves influencing the supply of money and interest rates to try and control the level of inflation, unemployment, economic growth and the value of sterling, or its exchange rate:
- Changes in the money supply may cause inflation It is believed by monetarists that an increase in the money supply, over and above an increase in the total output of the economy, will cause prices to rise. As the supply of money rises, people will have more to spend on goods and services. The increase in demand causes their prices to increase. Example: Since 1976 UK governments have tried to use monetary policy to control the growth of the money supply. - Changes in interest rate causes changes in aggregate demand Interest rates are the price of money. If interest rates fall, people and firms will find it cheaper to borrow, while others will be less willing to save money and will spend it instead. And as the interest rate fall, more people will want to spend more money. It reduces unemployment, and helps to create economic growth, as the economy will be able to produce more output in total. - Interest rates can be used to affect the value of the pound Interest rates can be raised to help increase the value of the country currency sterling compared to other countries currencies. Example: If interest rates are higher in the UK than in other countries, wealthy foreigners prefer to keep their savings in Britain and so earn high rates of interest on their money.

Examples on Monetary Policy:

Paul Volker, chairman of the Federal Reserve, 1979-1987, raised the interest rates dramatically to end the inflation of the late 70's. Alan Greenspan, chairman after Volker, cut interest rates immediately after the stock market crash of 1987, during the recession of 1991, and the recession of 2002. - Open Market Operations It refers to the borrowing and repayment of Government debt to the general public. The Bank of England can borrow money from the public by selling them promises to pay called treasury bills (last for 91 days). - Interest Rates The discount rate is the interest rate that central banks, Central banks use discount rate lending to control the money supply and to help troubled banks. For example: The Federal Reserve in the United States, charge for lending to financial institutions.