Describe how monetary policy is currently formulated in the United Kingdom and assess how effectively it can be used to manage the economy.

Monetary policy relates to the control and adjustment of money supply through monetary policymakers (Casu, Girardone & Molyneux, 2006). The aim is to secure price stability. Monetary Policy often involves inflation targeting as part of the framework and functions through reorientation of the demand-side, via adjustment of the interest rate set to banks and quantitative easing, which is the purchasing of a predetermined quantity of bonds to stimulate the economy and increase liquidity (Bullard, 2010). This essay will examine monetary policy in the United Kingdom, while also weighing the efficaciousness in controlling economic variables, which is contested between the seven main schools of economic thought. The debate involves the preferential use of the three main macroeconomic policies in managing an economy: monetary, fiscal and supply-side policy. empirical evidence will be evaluated.

Monetary policy is a flexible policy which be used to achieve different goals. Monetary policy in the UK has operated under flexible inflation targeting since 1992. There has been alteration in the setting of monetary policy, such as the framework adapted in 1997 to allow central bank independence in decision making (McCafferty, 2017). This has allowed less manipulation in policy setting which aligns with political agenda, thus negating social and economic consequences in the longer term. In addition, there has been an aim to greater increase transparency via publication of inflation and monetary-policy reports (Haldane, 1997). The policy is carried out by the UK central bank, or more specifically the monetary policy committee (MPC). The policy is set and announced eight times a year. The MPC utilizes full dependence and is run by nine members, the estimated time lag for monetary policy by the Bank of England is two years. Thus, forecasting predictions of inflation and economic growth in the foreseeable future is critical. The procedure of setting new policy involves a summation of MPC meetings. It starts with a pre-MPC meeting, where members view the latest data and analysis on the economy. Then, there are two meetings regarding a discussion on the contemporaneous data and the future direction of monetary policy. Finally, there is a meeting where the Governor – currently Mark Carney recommends their favoured policy. Ultimately, the prevailing policy is chosen by a majority of votes. If the inflation target is missed, the Bank of England Act 1998 commands the Governor to write a letter to the Chancellor of the Exchequer explaining the solutions to rectify the problem, and the expected time period for inflation to remain outside the given target (Parkin, Powell & Matthews, 2007).

The effectiveness of monetary policy is contentious within Economics. There are seven main schools of economic thought, where each one has a differing view on the efficacy of monetary policy.  Classical economists such as Adam Smith, David Ricardo and Irving Fisher view monetary policy in the long run having no effects on real variables of the economy, and only leading to a higher price level (Chan-Lee & Kato, 1984). Analogously, fiscal policy under some assumptions has no use in affecting employment and output. If government spending were to increase, interest rates would rise and a complete crowding out of private investment would occur, however price level would remain unchanged. Thus, under this view demand-side policies such as monetary and fiscal policies merely affect the interest rate and or price level (Heijdra, 2009) while in dichotomy supply-side policies affect real wage, employment and output. There has been an evolution to the theory and became another school called new classical, with a heavier emphasis on mathematical techniques and the role of rational expectations (Greenwald & Stiglitz, 1987).

Keynesians use the phenomenon of the liquidity trap to argue the ineffectiveness of monetary policy. Suppose the rate of interest is sufficiently low analogous to the pervasive sub-zero rates observed currently. Also, that the level of spending at this interest rate is insufficient to support full employment of the factors of production, plus prices and wages are fully flexible. Under these conditions, Keynes argued that price and wage reductions will not restore equilibrium (Mankiw, 2015). Hence, market forces wo