8/12/2019 Monetary Policy Committee

1/2

Monetary Policy Committee

Should the MPC increase or decrease interest rates.

Monetary Policy involves the use of interest rates and other instruments of policy to influence the

growth of aggregate demand. The Monetary Policy Committees main objective is to maintain a

target rate of inflation of 2%, this is considered by the MPC as price stability.

Currently the UKs rate of inflation is at 1.9%; this is below the target of 2.0% and therefore I believe

the MPC needs to decrease the interest rate or keep the interest rate the same to increase inflation.

If interest rates decreased then investment would increase due to investments becoming more

profitable this is called the MEC theory; aggregate demand will then increase due to the increase in

investment. When aggregate demand increases price level will also increases which causes inflation

to increase. Moreover if investment in to capital increases then the UK s GDP would also increase as

there would be an increase in the amount of goods and services produced in the UK. This would

increase the percentage change in GDP which is currently at 0.7% and can lead to an increase in

consumer and business confidence. The UK business confidence reflects the UK GDP growth rate;

from the graphs we can see that GDP fell from 0.8 to 0.7 in the first quarter of this year and UK

business confidence also fell from 24 to 21 in the first quarter of 2014. So if GDP increases then the

business confidence will also increase.

Decreasing interest rates would also decrease the return of savings and also lower the cost of

borrowing; this means that consumers will borrow more and save less leading to an increase in

consumer spending and because aggregate demand is C+I+G+(X-M), it will increase causing an

increase in price level increasing inflation. Furthermore if consumer spending increases and real

national output increase then cyclical unemployment will decrease as cyclical unemployment is

determined by RNO. This can be seen from the increase in consumer confidence from -13 in January

2014 to -7 in February 2014, and the fall in unemployment to from 7.1% in January to 7.0%.

8/12/2019 Monetary Policy Committee

2/2

A decrease in interest rate would also decrease the demand for UK savings as savers would receive

less money from saving which will lead to the decrease in the demand for the pound. If demand for

the pound decreases then there will be depreciation of the exchange rate; this leads to exports

increasing as it will be cheaper for foreign countries to buy goods and services from the UK. The rise

in level of exports will increase aggregate demand. From the graph on UK exports, towards the end

of 2013 the level of exports dropped decreasing the output gap slightly. Going into 2014 the level of

exports starts to increase again and to sustain that increase the interest rates will need to be

decreased or kept the same.