Monetary policy involves the manipulation of the Money Supply or the rate of interest by the monetary authorities.
Monetary Policy used to be carried out by the government, but it is now the independent Bank of England which sets the interest rate.
The purpose of Monetary policy is:
1. Target the rate of inflation. Government’s target is 2% +/-1.
2. Influence the level of economic activity, economic growth and unemployment.
The role and function of the Central Bank
- The issuing of notes and coins. This allows the Bank of England to control the Supply of cash in the economy. In certain circumstances the Bank of England may decide to increase the money supply through a policy of quantitative easing. (increasing money supply and buying government bonds)
- The Banker to the commercial banks. E.g. commercial banks like Lloyds will have an account at the Bank of England.
- Acting as a lender of last resort. If commercial banks need to give money to their customers they can always borrow from the B of E.
- Set the base Interest rate which determines the Mortgage rates and other commercial interest rates