Monetary Policy Committee of the Bank of England
The Monetary Policy Committee (MPC) is a nine-member committee that meets eight times a year for the purpose of changing the bank rate for the United Kingdom (UK). Five of the committee members are staff of the Bank of England (BoE) while the remaining four members are external members appointed by the chancellor. The BoE’s staff members are the governor, chief economist and three deputy governors in charge of monetary policy, financial stability, and markets and banking.
The bank rate is the interest rate charged by the BoE on its loans to commercial banks. The bank rate determines all other interest rates in the UK. The MPC meets in order to determine whether to increase, decrease or leave unchanged the bank rate in order to ensure that inflation is as close as possible to the 2% target set by the UK government. The rate is altered after studying a lot of data about the domestic and international economy, e.g. wage growth, services inflation, the output gap, real GDP growth rate, oil prices, gas prices and exchange rate.
If there is inflationary pressure in the economy, the bank rate will be increased by the MPC. This makes commercial banks raise their interest rates too. Borrowing will be discouraged while saving is encouraged. Besides, consumption and aggregate demand decrease, thereby reducing the inflation rate. For example, the MPC had to increase BoE’s interest rate to curb the inflation fuelled by higher energy prices as a result of the invasion of Ukraine by Russia. If the inflation rate is below the target of 2%, say 0.5%, the MPC will reduce the bank rate; banks will respond by lowering their interest rates which encourages more consumption and less saving. This increases aggregate demand and the inflation rate so that it meets the target set by the government for the BoE.
Problems faced by the Monetary Policy Committee
Time lag in monetary policy transmission
It takes time for the impact of the policy to be felt in the economy. And because economic variables change from time to time, the policy could become outdated before it is transmitted through the economy. A monetary policy, such as an interest rate increase, can take up to two years to achieve its objective.
Models are unrealistic
Models are used in determining the trend of the price level and making predictions about the expected inflation rate. Models cannot accurately represent the economy; the economy is complicated with many variables at work simultaneously. So models cannot accurately predict future economic outcomes.
The data considered before changing the bank rate are usually for a short time, e.g. monthly. Therefore, the bank rate may not work over a long time.
There are certain events that happen outside the country but have an effect on its economic variables. These events are not within the country of the domestic economy. They can raise the price level in the country unexpectedly. And they are capable of making the predetermined bank rate ineffective. For instance, a strong demand for oil by China can raise the price of fuel and cause inflationary pressure in the UK.