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Word Count: 1,428
Monetary policy in Britain after 1985 was focused on controlling the demand for money via the interest rate policy The basic part of this policy was the emergence of the exchange rate as a target The exchange rate was emerged after the collapse of the MTFS which role was to reduce inflation by reducing the growth rate of the broad money M3 supply while reducing the PSBR This policy was not very successful since on most cases the growth of the M3 exceeded the MTFS targets The exchange rate works effectively through the interest rate policy because if the interest rates are raised to attractive for the foreign investors levels there will be an inflow of money from abroad This inflow of money will increase the demand for domestic money increasing the exchange rate In the UK the demand for money increased and with the increase in the money supply resulted to a deep financial deregulation of the financial markets Big Bang This increased competition between the financial institutions which took more risks and increased lending This action increased the demand for money because of the easier access to credit resulting to a spectacular boom in consumption and a fast GDP growth rate At the same time the Bank of England tried to keep interest rates low During the next three years from 1986 the nominal interest rate remained unchanged and the real interest rates decreased In order to achieve interest rate stability money was allowed to grow at an annual rate of 20 which was the main reason for the rapid inflation in 1989-90 Another reason for the expansion of demand was the fall in oil prices in 1986 which mainly effected the private sector of the economy working as a cut in indirect taxation There was no action taken under the MTFS to off set the lost tax revenues so this resulted to a price cut and demand and liquidity increase
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