Interesting rates
What is the price of money? Who decides on it? How does the price of money affect what you pay for your shopping? And investment by businesses?
If you have never thought that the European Central Bank’s (ECB) monetary policy could be of any interest, grab some earphones and listen in to the Europe Room at the Banco de España, because we are discussing interest rates that interest you.
19/03/2025
How are prices affected when the ECB raises or lowers interest rates?
Perhaps when you hear people talking about monetary policy, you think of it as an economic concept that has little to do with your day-to-day life, but nothing could be further from the truth.
Monetary policy is in the hands of the ECB, and when it fixes interest rates, it sets the price of money. This price is what banks are charged when they borrow funds and what they are paid when they deposit their money, their liquidity.
This situation then plays out across the wider economy, when banks lend to or deposit money with each other and when you borrow from or deposit money with your bank. This entire process is known as the monetary policy transmission mechanism and, via interest rates, it also affects the price level within the economy.
The ECB decides to raise interest rates when inflation, the rate at which prices are generally increasing in an economy, climbs too high. High inflation is undesirable as it reduces households’ purchasing power, making it more expensive to buy the things they need. Businesses also face challenges because the cost of the materials they use for production rises, leaving them with fewer resources to invest and grow. With higher interest rates, both households and businesses have less incentive to borrow money for consumption or investment, which means that prices ease.
Conversely, when interest rates are low, it becomes cheaper for both households and businesses to borrow, leading to an increase in consumption and, consequently, higher prices.
The ECB aims for price stability so as to ensure steady and sustained economic growth. This goal is considered to be met when inflation stands at around 2% in the medium term.
To achieve this, economists from the Banco de España and other national banks in the Eurosystem analyse numerous economic variables and convey all the information to the Governing Council of the ECB, which then decides on the optimal path for interest rates in order to maintain price stability. This is their contribution to economic growth and job creation across the euro area.
