One of the Bank of England’s key responsibilities, as the central bank of the UK, is the conduct of monetary policy. The Bank’s role is to deliver price stability (as defined by the Government’s inflation target) by setting short-term interest rates. The purpose of this Fact Sheet is to explain some of the background to monetary management in the UK and set in context the discussions of policy that appear in successive issues of the Bank’s Inflation Report and Quarterly Bulletin. The focus is mainly on how monetary policy is made and then put into effect.

The objective of monetary policy is price stability - to maintain the value of money - or, to put it another way, to restrain inflation or the general increase in the prices of goods and services. Uncertainty about inflation - and thus about 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 rational decisions taken about whether to save or to borrow, how much to invest and to consume, and what and when to produce. In this way, price stability can help to foster sustainable long-term economic growth.

Monetary policy operates by influencing the cost of money, i.e. the short-term rate of interest. The Bank 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), consumer and business demand and, ultimately, output and employment. Broadly speaking, the objective is to keep aggregate demand as far as possible in line with the productive capacity of the economy. If rates are set too low this may encourage the emergence of inflationary pressures so that inflation is persistently above target. If they are set too high there is likely to be an unnecessary loss of output and employment, and inflation is likely to be persistently below target.

Reproduced by kind permission of the Bank of England