Transmission Mechanism

• The Transmission Mechanism (Steps 1 - 3):

  Inflation is above the Target rate (1-3%). The Monetary policy Committee meets and decides to raise the Base Interest Rate. High Street Banks react to this, increasing their interest rates on loans, mortgages, and saving accounts
• The Transmission Mechanism (Steps 4 (MPS))

  This will make savings more attractive, so the Marginal Propensity to Save should increase, which will weaken the effect of the multiplier on aggregate demand.
• The Transmission Mechanism (Step 5 (loans))

  Loans become more expensive, meaning businesses and consumers are less likely to take on new debt, meaning consumption and investment will reduce, causing real GDP to fall
• The Transmission Mechanism (Step 6 (Mortgages))


  Households on a variable rate mortgages will have a higher repayment cost, which will reduce their disposable income, and consumption will fall further
• The Transmission Mechanism (Step 7 (Businesses))

  Businesses will react to higher costs to supply and less demand, by reducing the size of the workforce, increasing unemployment
• The Transmission Mechanism (Step 8 (END))

  This will lower inflationary pressure as both Demand pull and Cost push inflation will reduce, so the inflation rate should fall