
Monetary policy transmission
The principal policy instrument that the Central Bank uses to attain the inflation target is its interest rates on transactions with other financial institutions, which then affect other short-term rates in the money market. In this way, monetary policy affects individuals’ and firms’ saving and spending decisions. The interest rate level affects demand – i.e., the consumption and investment of individuals, firms, and the public sector – which ultimately affects the price level. If the Central Bank deems it appropriate, it can also conduct transactions in the interbank foreign exchange market, with the aim of affecting the exchange rate of the króna and thereby affecting the price level.
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Interest rates
Impact on the credit system
Exchange rate channel
Asset price channel
Expectations
Transmission mechanism
A detailed discussion of monetary policy transmission can be found in the article by Thórarinn G. Pétursson, “The monetary policy transmission mechanism”, in Monetary Bulletin 2001/4, and in the handbook for the QMM: “QMM: A Quarterly Macroeconomic Model of the Icelandic Economy”, Ásgeir Daníelsson, Lúdvík Elíasson, Magnús F. Gudmundsson, Svava J. Haraldsdóttir, Lilja S. Kro, Thórarinn G. Pétursson, and Thorsteinn S. Sveinsson.