Economic Assignment: Inflation, Interest Rate and Monetary Policy Committee in UK

Running Head: ECONOMIC ASSIGNMENT
Economic Assignment
Name of the Student
Name of the University
Author note

1ECONOMIC ASSIGNMENT
Table of Contents
Introduction......................................................................................................................................2
Real interest rate..............................................................................................................................2
Role of Monetary Policy Committee in controlling UK inflation...................................................3
Risk of deflation in UK economy....................................................................................................5
Demand side policy responses of Global Financial Crisis..............................................................7
Impact of rising value of pound on aggregate demand....................................................................8
Conclusion and Recommendation.................................................................................................10
References......................................................................................................................................12

2ECONOMIC ASSIGNMENT
Introduction
The case study is prepared based on the dynamics of inflation, interest rate and monetary
policy committee on United Kingdom. Monetary Policy Committee of Bank of England is
responsible for designing monetary policy in the economy. The committee is ready to adjust the
interest rate in line with fluctuation in the price level. In the phase of rising inflation, the
committee raises interest rate while during a declining phase of inflation MPC sets the interest
rate to a low level. Given a relatively low inflation rate, MPC currently does not have any
pressure for raising inflation rate. The case study discusses the concept of real interest rate along
with assessing the role of MPC in controlling inflation. Additionally, the demand side policy
responses of GFC and likely impact of a rise in value pound in aggregate demand is analyzed to
draw a firm conclusion regarding current state of economy.
Real interest rate
Interest rate represents the charge on borrowed fund. The nominal interest rate is the
interest rate that does not consider inflation rate into account. The inflation however affects the
effective rate of interest and hence, alters the burden of interest. During inflation, the value of
money reduces. Hence, borrower paying nominal interest rate gain while lender loses because of
a small effective return. Reverse is the case during a downward movement of price. Therefore,
inflation should be taken into consideration for evaluating real return of funds. The real interest
rate is the inflation adjusted return (Goodwin et al. 2015). The interconnection between nominal
and real interest rate and that of inflation rate is stated by the Fisher Equation given as
Real interest rate=Nominal interest rate−inflation rate

3ECONOMIC ASSIGNMENT
Real interest rate is a tool to understand the nature of monetary policy. A low real interest rate
indicates that a stimulatory monetary policy while a high interest rate implies prevalence of a
tight monetary policy.
Role of Monetary Policy Committee in controlling UK inflation
The monetary policy committee of UK has the responsibility to meet an inflation target.
The committee aims to maintain a targeted inflation rate of 2%. The monetary policy committee
design monetary policy to stabilize price and provides confidence to the currency. The
committee has faced some difficulty in achieving its inflation target in recent years. After the hit
of global recession UK CPI inflation is average at 3%. In December 2013, the inflation backed to
the level of 2% (bankofengland.co.uk 2018).
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
0
1
2
3
4
5 4.48
2.83 2.53
1.47
0.05
0.64
2.69 2.71
Average inflation
Year
Average inflation (%)
Figure 1: Inflation in UK since 2011
(Source: inflation.eu 2018)
The figure above shows the movement of price level in UK since 2011. After the global financial
crisis, because of unstable economic condition inflation has reached to a level of 4.48%, above
than the inflation targeting. Since 2011, inflation rate started to decline and become as low as