Today, central banks conduct monetary policy by altering the short-term interest rate to affect inter-temporal decisions on consumption and savings. This inter-temporal – or vertical – redistribution is at the heart of the monetary policy, which aims at price stability. A change in the policy rate is transmitted to other interest rates at various maturities through a long sequence of inter-temporal arbitrages.
Ultimately, any change in interest rates for consumers and firms affects saving, investment and spending decisions through an inter-temporal substitution effect. Monetary policy also affects the distribution of income on the intra-temporal – or horizontal – dimension. Changes in short-term interest rates impact on consumption, savings and wealth in different ways, depending on the characteristics of individual households.