The overarching goal of a central bank is to maintain price stability.
Monetary transmission mechanism is the process whereby a central bank’s interest rate gets transmitted through the economy and ultimately affects the rate of increase of prices—that means, inflation.
Suppose that a central bank announces an increase in its official interest rate. The implementation of the policy may begin to work through the economy via four interrelated channels.
The central bank’s policy rate works through the economy via any one, and often all, of the following interconnected channels:
- Short- term interest rates;
- Changes in the values of key asset prices;
- The exchange rate; and
- The expectations of economic agents.