The methods of monetary policy transmission refer to the manner in which the targeted effects of monetary policies are transmitted through the economy in order to achieve the desired result. Central or reserve banks are the only banks that have the power to make monetary policies due to the fact that they have the exclusive monopoly over the supply of base money to all others. Usually, the monetary policy involves the rate at which they choose to set the interest on the money that they supply to the other banks. In this sense, the official interest rate has various degrees of effects on market rates, which radiate from its decisions to increase or decrease the official interest rate.
As such, the methods of monetary policy transmission can be traced along the line or chain of effects from the central bank. For instance, a method of monetary policy transmission is the transfer of the increase or decrease in the official interest rate to mortgage rates. Assuming the central bank’s intention is to reduce the rate of inflation by causing a decrease in the rate of demand by consumers, it will increase the interest rate to a degree that it feels is proportionate to address the excessive demand. This increase can only be up to a certain predetermined maximum level in order for the central bank to maintain its influence through the manipulation of interest rates.
When the banks obtain money from the central bank with the increased interest rates, they transmit the charges to both the borrowers and savers in different forms. One of these methods is to increase the interest on debts owed them as well as on other types of loans that people try to obtain from the banks, such as mortgages and car loans. The increase in interest rates will also be transmitted through factors like a depreciation in the value of equities and bonds as a consequence of a rise in long-term interest rates.
Methods of monetary policy transmission also include the exchange rates, because the value of exchange rates are affected by monetary policies. A method of monetary policy transmission that affects the savings of people in the transmission of monetary policy is an increase or a decrease in the amount of interest paid on savings deposits. When the interest rate is high, banks will often increase the interest rate on savings in an effort to encourage more people to save. In reaction to a low interest rate, the banks will transmit the intention of the central bank to the customers by decreasing the interest that is paid on savings in an effort to encourage more customers to spend.