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In the past it was traditional for UK Governments to use “Monetary Policy” i.e. to control the level of interest rates or the level of exchange rates in order to achieve government objectives.

Today this is no longer the case: the UK Government does not attempt to control either exchange rates or interest rates. This does not mean, however, that exchange rates and interest rates are not of vital importance to businesses in the UK. They are a constant concern for businesses and are keenly watched by them. However, it is now the Bank of England which sets the “base” interest rate in the UK, whilst the exchange rate (how much foreign currency you get for a £1) is left to the forces of supply and demand i.e. our exchange rates fluctuate by the day, hour and minute!

The Bank of England is, at the time of writing, set a very specific task by the UK Government: to maintain inflation at 2.5% per year. This means that inflation below 2.5% is just as bad as inflation above 2.5%. Inflation doesn’t have to be exactly 2.5%, it will fluctuate month by month, but it should be close to 2.5%.

Task
Find out more about the Bank of England and its target of 2.5% by visiting the following web page: “Target 2 Point 5 - An Independent Bank of England”. This page is part of a large website supporting a competition for schools run by the Bank of England.

The Bank of England will periodically alter the “base” interest rate in the UK economy in order to achieve its target of 2.5% inflation. By increasing the base interest rate, demand for products will fall (people and businesses borrow and spend less), thus reducing inflation. Increasing the base rate will have the opposite effect. These changes in the base interest rate will affect businesses. Click on the following links to find out more:

• Interest rates
• Exchange rates