Evaluation of Interest Rates

You should be familiar with how interest rates can control inflation in the economy via the monetary policy transmission mechanism.

You should also be able to evaluate how effective interest rates are in controlling inflation.

One useful tip is to remember that interest rates take two years to fully work their way through the economy.

There is further analysis of the usefulness of the policy you can read about here: Monetary policy will not be enough to fight the next recession (The Economist)

The following is a typical examination question using these skills:

Using the following data and appropriate economic analysis, consider the extent to which interest rates appear to be an effective tool for controlling inflation. (8)

The mark scheme for this assessment will look like this:

AO1 Knowledge	2 Marks Good understanding The concepts of interest rates and inflation are both clearly understood. A definition is not required; knowledge may be shown in passing.
AO2 Application	2 Marks Good application Effective use is made of the charts, making specific reference to time periods (at least 2)
AO3 Analysis	2 Marks Good analysis Clear explanation of how interest rates in principle should be able to control inflation. Top answers will refer to more than one channel of the monetary policy transmission mechanism.
AO4 Evaluation	2 Marks Good evaluation A well-developed counterargument is made, suggesting why the analysis in AO3 may not be true.

Tasks:

Explain (AO3) why changes in interest rate will impact inflation.
Use the data to identify (AO2) periods where interest rate policy seemed to be controlling inflation (remembering there is a 2-year lag for monetary policy to work fully)
Use the data to identify (AO2) periods where interest rates seemed to be unrelated to inflation.
Explain (AO4) possible alternative reasons for what may have affected inflation in this time.