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Summary

The inter-relationship between the demand for money, the supply of money, interest rates and the effect on nominal income and prices is extremely complex. Economists have spent many years trying to study these relationships. There is widespread agreement that there is a relationship between the supply of money and nominal income and prices. There is also agreement that controlling interest rates in the economy is a means of influencing inflation rates. The success of the Bank of England in the UK in maintaining a more stable rate of inflation since 1997 has been widely recognised. Most central banks in the western world use some form of monetary policy as a primary means of influencing the level of economic activity and inflation rates.

The extent to which these central banks fully understand the relationship between what they do in the name of monetary policy and the effect on the economy is less certain. The evidence of the effects that central banks' actions have on the whole of the economy is not as clear and unequivocal as might be thought. The Bank of England will be using research into the links between interest rate policy and the economy as the basis for its decisions.

The Bank of England makes important policy decisions on interest rates that affect the whole of the economy. Do they fully understand the consequences of their decisions? Copyright: Paul Preacher, from stock.xchng.

Ultimately, because economics can only ever be an imperfect science, exactly what the effect of their policy decisions are on the economy can only ever be a judgement, albeit a judgement based on the best available evidence from economic research. The Bank of England is not the owner of all the knowledge about how the economy works, and as global markets change, it might be seen as constantly one step behind what happens in the real economy.

There are still arguments about the extent to which monetarism still exists as a school of thought and what effect monetarism has had on western economies. In some respects, it could be argued that the relatively stable economic conditions that the UK has enjoyed in the last 10 years have been due to the hard decisions taken in the name of monetarism in the 1980s and 1990s. The decision to give operational control of monetary policy to the Bank of England rather than leaving it in political hands in 1997 is another manifestation of this success. Others might point to different reasons for the stability of the UK economy. What is not in doubt is that monetarism has played its part - the debate surrounds the extent of the part played by monetarism.

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