It may be surprising that we have completed two chapters dealing with money and the role of the central bank but have only peripherally mentioned interest rates. This approach was chosen deliberately. The fundamental role of the central bank is to control the supply of money in the economy. Effects on interest rates are a product of this control, so a prerequisite to any discussion of interest rates is a knowledge of the role of money creation.
Monetary policy influences interest rates in two distinct ways, depending on whether or not the monetary policy affects inflation. The purpose of this chapter is to discuss how monetary policy affects the interest rate in a noninflationary environment and how the interest rate in turn affects the operation of the economy. Chapter 11 examines interest rates in an inflationary environment.
