Monetary Policy

Meet once a month and consider a wide range of statistical indicators which help them decide the nature of inflation for the coming month. The primary goal of the MPC is to "deliver price stability whilst supporting the growth and employment goals of the government's economic policy" (source: Bank of England).

A secondary role of the MPC, as suggested by its behaviour, is to frequently publish information regarding inflation. This is based on the Monetarist school of thought, especially the Adaptive Expectations hypothesis pioneered by Milton Friedman. An awareness and expectation surrounding inflation will reduce 'money illusion' and short term fluctuations in unemployment. Actual decisions made to vary the interest rate are carried out in a democratic matter monthly – changes are made in the 2. 5% to 5% band.

Interest rates are also important as an intermediary tool of fiscal policy as govt borrowing is financed according to the relative cost of borrowing – the IT. The Committee reviewed monetary and economic developments in the light of its latest quarterly projections for output and inflation, to be published in the February Inflation Report. RPIX inflation has, as expected, moved a little above target, but this is the result of temporarily large contributions from petrol prices and from housing depreciation.

These influences on inflation will persist for some time but are expected to unwind further ahead. Over the next two years, the prospects for demand, both globally and domestically, are somewhat weaker than previously anticipated. In order to keep inflation on track to meet the target over the medium term, the Committee judged that it was necessary to reduce interest rates by 0. 25%. Interest rates are a tool for the adequate manipulation of the economy. The official 'repo' rate is the rate at which banks can lend money. It is determined using the transmission mechanism and the money supply.

The Bank will deal with a small group of counterparties acting in the money markets. The Bank will buy assets on the understanding that they will be sold back a fortnight later. An example of such an asset would be Treasury Bills. If the Bank wanted to reduce the money supply and thus increase the interest rate, bills would be bought and then sold at a higher price. This price change would cause a reduction in the supply of money and hence an increase in the interest rate. This is a simplification as other variables have an influence.

There have been notable gains from the actions of the MPC. As mentioned earlier, during the past few years, long-term interest rates have been suppressed leading to greater private investment. This is certainly a boon for the economy as manufacturing has been in severe decline since 1995. Also, it has encouraged consumer expenditure as a means of propping up the economy through sustained aggregate demand. However inflation has remained historically low, hovering around the 3% mark. A sense of cooperation and political non-involvement has been paramount to such success.

Another possible explanation for this is that the strength of the Pound against the Euro has been sustained. This has had a twofold effect: the price of exports has risen and price of imports has fallen. A big factor in the case for sustained low inflation is that expectations of inflation have been redeveloped. The general populace and firms in general believe that an independent Bank of England is keeping inflation under control. Money illusion and cost push inflation have been reduced: Not everything is a positive development of an independent Bank of England.

The science of determining interest rates and monetary fine-tuning is not exact and sometimes there can be disagreement as to the extent of the size of change required to maintain growth and price stability. The Bank cannot determine an outcome, only influence it. Critics also argue that the Bank and MPC react too strongly to short term indicators and should more emphasis on research towards log term trends. Some complain that there are divisions between the members of the Bank; for example, Hawks outweighing the Doves: pessimism about inflation is too great making employment and stunted growth likely: not juggling properly.

In retrospect, the MPC and an independent Bank of England is the best thing to have happened to the British economy for many years. The numerous plus points; low inflation, high growth, low unemployment amongst others vastly outweigh any, frankly unsubstantiated negatives. Also, an independent BoE is essential for the UK's entry into a unified Europe with a single currency. This economic and political step will be taken in the future, particularly if the Pound maintains its weight against the Euro…