INVESTING EXPLAINED: What you need to know about monetary policy… how central banks try to run interest rates
In this series, we bust the jargon and explain a popular investing term or theme. Here it’s Monetary Policy.
What is it?
The name economists give to actions taken by central banks to achieve economic goals set by the government. Fiscal policy, which focuses on taxation and spending, is the other main way in which a government can manage the economy.
Who implements this policy?
Central banks, such as the Bank of England, which has operational independence of the government.
The Bank of England has been charged with keeping inflation at 2 per cent (zero inflation would not be desirable). The Federal reserve, the US central bank, is responsible for keeping prices stable, but also for maximising employment.
Goals: Monetary Policy is the name economists give to actions taken by central banks to achieve economic goals set by the government
What does monetary policy involve?
The aim is to control the supply of money circulating in the economy and also the cost of borrowing that money. Central banks rely on two tactics: raising or lowering interest rates and asset purchase programmes, known as quantitative easing (QE).
This is the buying of bonds issued by the government (gilts) or companies, a manoeuvre intended to put downward pressure on interest rates and so stimulate the economy. Since 2009 the Bank of England has amassed £895billion of bonds through QE, but it is now bringing to an end this era of easy money. In the US, the Fed is engaged in a similar ‘tapering’ effort.
How is the campaign on inflation going?
Not well. inflation is at 5.5 per cent, a 30-year high and the Bank says it may exceed 7 per cent by the spring, although it should then fall back. higher inflation has been attributed to various causes including global supply chain issues and soaring energy prices which are being further fuelled by the war in Ukraine.
How is the Bank responding to rising inflation?
The Bank’s Monetary Policy Committee (MPC) raised the base rate to 0.5 per cent in February, but further rises may now be delayed as a consequence of war in Ukraine.
The MPC – which is made up of Bank officials and independent members – next meets on March 17.
The Bank of England Governor Andrew Bailey – whose salary is £575,000 –called for pay restraint, but this did not go down well.
Does the Governor need to justify his actions on inflation?
Yes. if inflation moves away from the target by more than one percentage point either upwards or downwards, Bailey is obliged to send an open letter to rishi Sunak, the Chancellor.
The letter must set out why the target has been missed and what is being done to remedy this. These letters are published on the Bank’s website.