Thursday, March 4, 2010

Monetary Policy Announcement

Next week, we'll start learning about monetary and fiscal policy, the two tools of macroeconomics policy.  Now we've got the ISLM model in hand, we can use that to discuss these types of policy.

As an early heads up, today the Bank of England's Monetary Policy Committee meets to decide on interest rates.  In 1997 the UK government gave the Bank of England independence, and gave it the task of setting interest rates to achieve the government's stated target for inflation - back then that was 2.5%, but then after the UK adopted the harmonised measure of inflation the target became 2%.

The full expectation is that rates will stay at zero - or 0.5, the lowest that they can practically go.  The Bank of England's governor, Mervyn King, has hinted at starting up quantitative easing again - this is a policy that only needs to be used when interest rates have hit their rock bottom level - where we saw the interest rate mechanism no longer works for transmitting changes in the money supply into economic growth.

What we'll find out next week in lectures is that the bank doesn't exactly "set" the interest rate, but once it's agreed what the interest rate should be (so, 0.5% from today), then the Bank will engage in buying and selling financial assets (usually government bonds) to manipulate the money supply to achieve that rate of interest.

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