Policy Rate

Question 1

5 Transmission Channels of a Policy‑Rate Hike

Answer 1

1. Interest‑sensitive spending
     Rate ↑ → loan costs ↑ → big‑ticket purchases deferred → ↓ C, ↓ I
   
   2. Exchange‑rate
        Rate ↑ → capital inflow → currency stronger → exports dearer, imports cheaper → ↓ NX → ↓ GDP, ↓ π
   3. Asset‑price / wealth
        Rate ↑ → share & house values ↓ → households feel poorer → ↓ C
   4. Bank‑lending (credit supply)
        Rate ↑ → bank funding & capital cost ↑ → fewer new loans → ↓ I, ↓ SME spending
   5. Balance‑sheet
        Rate ↑ → asset prices & cash‑flows ↓ → collateral weaker, risk premia ↑ → ↓ credit demand & supply

Question 2

Inflation Targeting – What, Why, Strengths & Limits

Answer 2

What? Central bank commits to a CPI target (e.g. 2%) using rates
• Why? Anchors expectations, solves time inconsistency, avoids inflation bias
• Strengths: Simple, transparent, stabilises inflation without big recessions
• Limits: Ignores asset bubbles, can be too rigid, delayed reactions, neglects other goals

Question 3

Unsterilised FX Intervention

Answer 3

• Central bank buys foreign currency and prints new home currency to pay for it.
• Nothing is traded out — so the total money in the system goes up.
• Both the exchange rate and the money supply change.
Because your buying dollars your currency going to fall regardless

More pounds in circulation more demand for foreign

Question 4

Sterilised FX Intervention

Answer 4

Central bank buys foreign currency, but then sells bonds to take the extra money back out.
• So one thing is traded in, the other is taken out — keeping the money supply stable.
• Only the exchange rate is affected — not inflation or interest rates.