A Changing Financial Environment and the Implications for Monetary Policy

Monetary policy affects activity, and ultimately inflation, in a number of ways. The most important of these is generally considered to be through the effect of interest rates directly on the demand for goods by households and firms. However, monetary policy can also influence activity through its impact on the value of assets that, in turn, will influence the behaviour of households and firms; e.g. by changing wealth and, through an impact on balance sheets, borrowing costs. Recent financial market developments may have made these effects of monetary policy more important but at the same time less easy to predict. In particular, the size of financial markets has risen relative to activity and readily tradable assets are becoming increasingly important relative to other financial assets. Prices of such assets tend to be sensitive to shifts in market expectations about the future course of general economic developments and in particular interest rates. With these changing financial ...