ABSTRACT
This chapter is concerned with how and why central banks change their policy rates, and what happens when they do. It examines the consequences of such interest rate changes: what happens to other interest rates, to key elements of aggregate demand, and to inflation. In countries that attempt to target the exchange rate, the monetary authorities will watch international interest rate differences keenly. If interest rates abroad have just risen, if treasury bill and money market term structure data point to market expectations of interest rate rises in the near future, and if domestic output and inflation appear abnormally high, the monetary authorities at home will usually wish to raise rates. If an official interest rate increase is interpreted as a major assault on inflation, which is expected to succeed, bond interest rates would rise at the shorter end and fall at the long end of a maturity spectrum.
