Under inflation targeting regime, monetary policy rate (refinancing rate) is the key instrument. The change in the monetary policy rate, through interest rate channel, is reflected in aggregate demand and, ultimately, inflation dynamics. Monetary policy rate also affects the economy through credit, exchange rate and expectation channels.

 

The inflation forecast is an intermediate target and monetary policy decisions are based on it. Monetary policy decisions affect the economy gradually and its effect is fully realized in 4-6 quarters. Considering this, if inflation forecast is higher than the target, the NBG tightens monetary policy stance and increases the monetary policy rate. The increased policy rate is gradually transmitted to the market interest rates. Higher interest rate reduces demand for loans which finally restrains aggregate demand. Relatively lower demand eventually reduces inflation. In contrast, when the inflation forecast falls below the target, the NBG loosens monetary policy stance and reduces  the monetary policy policy rate. Lower interest rates push demand for loans up and stimulate aggregate demand. Eventually increased demand pushes inflation up to the target level.