What Determines the Level of Interest Rate in the UK And How the Changes in Interest Rate Affect Economic Growth - Essay Example

Most of the monetarist economists argue that monetary policy has a lot of power compared to fiscal policy in as far as inflation control is concerned. Monetary policy also includes changes in exchange rate value due to the fact that currency fluctuation affects macroeconomic activities. Interest rates in the United Kingdom are established by the monetary policy committee of the bank of England according to Cobham (2002). Therefore monetary policy makes a major contribution in determining the level of interest rates.

For instance in some countries the monetary authority might possess the power to authorize particular interest rates on loans a well as other financial deals. The monetary policy committee meets regularly to set the relevant interest rates. Monetary policies are defined in two terms that is either expansionary or contractionary. On one hand the expansionary policy increases the economies total money supply in a more rapid rate than usual. Contractionary policy on the other hand, expands the supply of money in a slower rate compared to the usual rate or even contracts it.

Implementation of Monetary Policy in the UK Monetary policy is usually implemented by either the country’s central bank or reserve bank. . This is due to the reason that settlement of transactions should take place daily as the business closes and thus banks without sufficient reserves borrow from the Bank of England to meet these obligations. The Bank of England is the only guarantor of such funds and is able to set interest rates in which it provides the funds. In implementing monetary policy the bank passes cost of interest rates to clients in commercial banks inform of interest charges on mortgages as well as other types of loan.

If the lending rate also known as dealing rate of the central bank changes, the bank makes an adjustment to their rates of lending. Through the relationship between lending rate and commercial rates, the bank of England is able to influence the interest rates in the market. This way the Bank of England upholds its implementation of the monetary policy. For instance incase inflation increases behold the target rate, the Bank is capable of hiking the lending rate charges on the commercial banks.

This is usually in an attempt to slow the rate of spending hence bringing back inflation to the right level. According to Richter (2008), the monetary policy of the Bank of England is to provide stability in prices and lower inflation thus supporting the economic objectives of the government including employment. The bank of England has three major tools which they use in implementation of monetary polices. The tools can be used in expanding or contracting supply of funds of the country based on response of the policy to current economic situation.

The three tools include: discount rates, open market operation rates and reserve requirements of changing banks. Reserve requirement is one of the tools used in