Monetary policy is one of the key policy instruments used to stabilise the economy, in particular, in recent years, to achieve a target inflation rate. In normal circumstances it operates through the setting of an interest rate. The Central Bank sets an interest rate – the Central Bank Policy Rate – which affects the terms on which commercial banks can borrow funds in the short term. If the Central Bank lowers its Policy Rate the commercial banks can borrow funds at a lower rate and can then in turn offer loans to their customers at lower rates. These lower rates should then encourage businesses and individuals to take out loans to finance higher spending. A higher Central Bank Policy Rate will have the reverse effect.
In response to the financial crisis many Central Banks cut their Policy Rates to unprecedentedly low levels. The Bank of England has set a rate of 0.5 for several years, and in some countries, e.g. Denmark and Sweden, these rates had become zero by 2014, and in 2016 Sweden set a negative rate of -0.1%.