One of the Bank of England's key responsibilities, as the central bank of the UK, is the management of monetary policy. The Banks role is to deliver price stability by setting short-term interest rates. The purpose of this essay is to focus mainly on how monetary policy is made and then put into effect this will involve the central banks operations in the money market and how they effect the level of short-term interest rates in the UK.
The main objective of the central banks monetary policy is price stability, to maintain the value of money or to put it another way, to control inflation or the general increase in the prices of goods and services. Uncertainty about inflation and also future price levels is damaging to the proper functioning of the economy. With a stable general price level individual price signals can be read more clearly, and more reasonable decisions can be taken about whether to save or to borrow, how much to invest and consume and what and when to produce. In this way price stability can help to promote sustainable long-term economic growth.
The central banks monetary policy operates by influencing the cost of money, in other words the short-term interest rates. The Bank of England sets an interest rate for its own dealings with the market and that rate then affects the whole pattern of rates set by the commercial banks for their savers and borrowers. This in turn will affect asset prices e.g. shares and property, consumers and business demand and finally output and employment. The aim is to keep aggregate demand as far as possible in line with the productive capacity of the economy. If short-term interest rates are set too low, demand may exceed supply this may encourage the appearance of inflationary pressures so that inflation is accelerating. If the rates are set too high there is likely to be an unnecessary loss of output and employment and inflation is likely to be decelerating.
