Monetary Policy Impact on Interest Rates and Markets
Monetary Policy and Market Reactions
Short-Term Interest Rates
An unanticipated change in the monetary policy rate is immediately transmitted to other short-term money market rates. Interbank rates are adjusted pari passu, affecting nominal rates of recruitment and placement time between 30 and 90 days. There is a slightly lesser intensity of nominal and real rates of securities deposits and loans up to one year, which highlights the central bank papal PRBC at 90 days and 360 days and PDBC of 90 days.
Long-Term Interest Rates
Although a change in the policy rate clearly causes changes in other short-term rates, the impact on long-term interest rates can vary. Long-term rates are affected by an average of short-term rates, both current and future, so the result depends on the direction and magnitude of the impact of the change in the rate of policy expectations about the future behavior of interest rates.
Exchange Rate
Changes in interest rates induced by monetary policy can also affect the exchange rate. This variable is the relative price of foreign currency in terms of Chilean pesos, and in that dimension depends on monetary conditions in Chile and abroad. However, the precise impact of a change in the policy rate on the exchange rate is uncertain, because the impact will depend on the expectations on interest rates and domestic and external inflation.
Asset Prices
Changes in the policy rate also affect the market prices of securities such as bonds and stocks. The bond price is inversely proportional to the long-term interest rate; thus, an increase in these rates causes a decline in bond prices. If everything else remains the same, an increase in interest rates also drives down the prices of other securities such as shares and property.
Liquidity, Money, and Bank Credit
Although the demand for money is unstable, it is certain that a change in the policy interest rate affects the quantity of liquid monetary assets such as currency and MIA. For example, an increase in the policy rate will have to be associated with monetary tightening since its upward effect on market interest rates implies that the cost to the public to keep those liquid assets rises, and then they decrease their quantity demanded.
Expectations
Changes in the policy rate can influence expectations about the future course of real activity by affecting the decision to invest and consume directly and thereby, potentially, the same inflation.
In short, the central bank acts directly on a specified short-term interest rate. Changes in the policy rate affect interest rates in the market, the exchange rate, and, to a lesser extent, asset prices. The response of these variables is not always the same but varies considerably from time to time, or the external environment, and the policy regime can be assumed constant.
Individual and Business Reactions to Currency Changes
Individuals
A change in monetary policy affects individuals in different ways.
- First, they face new interest rates for credit card debts and loans, so the disposable income of individuals and their incentives to save or borrow are altered.
- Second, the eventual more difficult access to credit for individuals who are eligible for credit more risky for banks with higher interest rates also affects their spending power.
- Third, the value of the wealth of the people also changes in response to changes in asset prices.
- Fourth, any adjustment in the exchange rate varies relative prices in local currency of many goods, services, and assets and liabilities in foreign currency.