What monetary policy is
- Monetary policy is the use of interest rates (and the money supply) to influence the economy.
- In the UK, the Bank of England's Monetary Policy Committee (MPC) sets the Bank Rate. Its main aim is to keep inflation at the government's 2% target.
How interest rates work
- Raising interest rates: borrowing becomes more expensive and saving more attractive, so spending falls. Mortgage payments rise, leaving less to spend. Business investment falls. Demand and inflation fall, but growth may slow and unemployment rise.
- Cutting interest rates: borrowing is cheaper, saving less attractive, so spending and investment rise. Growth increases, but inflation may rise.
- Interest rates also affect the exchange rate: higher rates attract foreign savings, raising the value of the pound.
Quantitative easing
- Quantitative easing (QE) is when the central bank creates new money to buy government bonds, increasing the money supply. It was used after the 2008 financial crisis and during the pandemic, when interest rates were already very low.
Key terms
- Monetary policy
- Using interest rates and the money supply to influence the economy.
- Bank Rate
- The interest rate set by the Bank of England.
- Monetary Policy Committee
- The Bank of England committee that sets the Bank Rate.
- Interest rate
- The cost of borrowing and the reward for saving.
- Quantitative easing
- Creating new money to buy bonds and increase the money supply.
- Mortgage
- A loan to buy a house.