Economics Monetary Policy Questions
The interest rate channel in monetary policy refers to the mechanism through which changes in the central bank's policy interest rate affect the overall economy. When the central bank lowers its policy interest rate, it reduces the cost of borrowing for commercial banks. This, in turn, encourages banks to lower their lending rates, making it cheaper for businesses and individuals to borrow money. As a result, increased borrowing and lending stimulate investment and consumption, leading to higher aggregate demand and economic growth. Conversely, when the central bank raises its policy interest rate, borrowing becomes more expensive, which discourages investment and consumption, leading to lower aggregate demand and economic slowdown. Therefore, the interest rate channel plays a crucial role in influencing borrowing costs, investment decisions, and overall economic activity.