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Monetary Policy


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Base rate
The interest rate set by the Bank of England which represents the 'cost' of creating money to high street banks and building societies.
Market rates
The rates for mortgages, savings, personal loans etc. set by banks such as RBS, HBOS, Barclays etc.
The Transmission Mechanism
The economic model used by the Bank of England which demonstrates how changes in the base rate feed through the economy to affect the rate of inflation.
Exchange rate policy
The use of exchange rates to achieve certain macroeconomic objectives e.g. in the 1980s the UK government 'shadowed' the german currency the Deutschmark in a bid to control inflation.
The quantity theory of money
The theory developed by Irving Fisher which suggests that control of the money supply is key to the control of inflation. It can be summarised by the identity MV = PT.
Quantitative easing
The purchase of government assets (e.g. bonds) by the Bank of England with newly created money. It's aim is to increase liquidity (available money) in financial markets.
The monetary policy committee
The group of nine economists who meet monthly to determine interest rates and also decide upon possible usage of quantitative easing.
Velocity of circulation
A variable in the Fisher identity (equation) it measures how rapidly money passes around the economy.
Time lag
This refers to the delay between the changing of the base rate and its full effect on inflation. It is estimated by the Bank of England to take 18-24 months.
Forward looking indicators
Economic variables that give some clue as to the future path of the economy, vital to understand if interest rates take 18-24 months to take their full effect.
Inflation target
A desired level for inflation. The government currently sets a target of 2% for inflation (+ or - 1) which the Bank of England used interest rates to try and achieve.
Open letter
The communication the Governor of the Bank of England must make with the Chancellor of the Exchequer whenever inflation is outside its targetted range.
Operational independence
The autonomy given to the Bank of England since 1997 to use interest rates independent of goverment to achieve an inflation target set by government.
Symmetrical target
The government's target for inflation is symmetrical - it does not want it to go to high or to low. Contrast this with the asymmetric target set by the ECB which just wants inflation below 2%.
Weak pound
When the pound cannot be exchanged for a substantial amount of another currency. This can cause cost-push inflation as import prices are higher.
Cost-push inflation
Inflation caused by increased costs e.g. increased energy prices etc. These are difficult for the Bank of England to control.
Demand-pull inflation
Inflation caused by an expansion of aggregate demand. The Bank tries to control this by increasing interest rates to bring down inflation and consumption.
monetarism
The school of economics which believes, according to Milton Friedman that "inflation is always and everywhere a monetary phenomenon" - they advocate controlling the growth of the money supply to contr