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Macro Year 1 > 12 - Monetary Policy > Flashcards

12 - Monetary Policy Flashcards

1
Q

What is a policy instrument?

A

A tool or set of tools used to try to achieve a policy objective.

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2
Q

What is a Central Bank?

A

A national bank providing financial and banking services for the government and banking system.

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3
Q

What are the objectives of monetary policy?

A

Sustainable economic growth, Keeping unemployment low, protecting the value of the currency.

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4
Q

What is the UK’s central bank?

A

The Bank of England.

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5
Q

What is the aim of the Bank of England?

A

Achieve monetary and financial stability by regulating the financial system, and lending government bonds.

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6
Q

What does the Bank of England do with monetary policy?

A

Sets interest rates, depending on the state of the economy.

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7
Q

What does monetary policy aim to influence?

A

Consumption, Investment, Net trade.

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8
Q

How does an increase in Interest rates affect Aggregate Demand?

A

Reduces household income, reduces business investment, affects imports and exports.

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9
Q

How does an increase interest rates reduce consumption?

A

Higher interest rates encourage people to save money, and means that less income is available for consumption, as more is spent on loan/debt repayments.

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10
Q

How does an increase in interest rates reduce business investment?

A

Businesses may postpone investment projects, as they believe that higher borrowing will make investment unprofitable.

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11
Q

How does an increase in interest rates affect imports and exports?

A

Higher interest rates increase demand for the pound, attracting capital flow into the currency, causing the exchange rate to rise, making exports less price competitive.

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12
Q

What has the main monetary policy tool been in the last 50 years?

A

Controlling inflation.

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13
Q

What is the target for inflation?

A

2%.

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14
Q

What happened to interest rates between 2009-2022?

A

Interest rates remained historically low, between 0.1-0.5%.

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15
Q

What did lower interest rates mean in the 2010’s?

A

People borrowed more money, and saved less, consumption was encouraged.

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16
Q

What do commercial banks charge money on?

A

Loans they give to each other, as well as customers.

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17
Q

What is the LIBOR rate?

A

The rate a bank pays when borrowing money from another bank.

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18
Q

Where does the LIBOR rate usually sit?

A

Just above the bank rate, during the financial crisis, the gap widened.

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19
Q

Why was the interest rate cut in 2009?

A

In part, because of LIBOR rates, which some say undermined the effectiveness of the 0.5% rate, as it didn’t fully stimulate Aggregate Demand.

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20
Q

What is Contractionary monetary policy?

A

Involved interest rates being increased, in order to take demand out of the economy.

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21
Q

What does this do to income, and AD?

A

The AD curve shifts to the left, and income falls from Y1 to Y2.

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22
Q

What is expansionary monetary policy?

A

Monetary policy which discourages saving, and encourages consumption.

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23
Q

What does expansionary monetary policy cause?

A

Exports increase, exchange rate falls, exports become more competitive, imports become less competitive.

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24
Q

What happened to the Bank of England in 1997?

A

It was made independent.

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25
Q

What type of relationship do bond yields have with interest rates?

A

An inverse relationship - as interest rates rise, bond yields fall.

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26
Q

What are gilts?

A

Fixed interest securities sold by the government, when they borrow in the long term.

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27
Q

What is a commercial bank?

A

A financial institution aiming to make profit, selling services to its’ customers.

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28
Q

What is an investment bank?

A

A bank which doesn’t accept deposits from members of the public, but does advisory work to companies.

29
Q

What is Systemic Risk?

A

The risk of a breakdown of the entire financial system, caused by inter linkages of the financial system.

30
Q

What does a one off risk affect?

A

A single bank.

31
Q

What does systemic risk affect?

A

The entire banking system.

32
Q

What have new regulations on banks been since the financial crisis?

A

Firms must separate investment banking from retail banking activities.

33
Q

What is the difference between cash and deposits?

A

Cash is tangible, but deposits are intangible.

34
Q

What are the assumptions of a monopoly system?

A

Only one bank in the economy, only has cash assets, it must always possess cash equal to 10% of customer deposits.

35
Q

What happens in a monopoly system, if a member of the public deposits £1000 into the bank?

A

Assets and liabilities increase by £1000. The cash is an asset, but the deposit is a liability, as it’s in the customer’s name.

36
Q

What are the examples of Banks?

A

HSBC, Barclays, Lloyds, Natwest.

37
Q

What happens if all banks expand deposits?

A

Payments to customers of other banks will cancel out.

38
Q

Where would bank profits come from, if a bank held all its’ assets in cash?

A

Fees it charges customers, for keeping their deposits safe.

39
Q

What would 100% cash mean for a Bank’s liquidity?

A

It would be completely liquid, but not profitable.

40
Q

Why does a bank have to use cash?

A

To allow banks to make advances to customers.

41
Q

How do firms try to maximise profitability?

A

Preserving liquidity.

42
Q

What do banks have to trade off between?

A

Security, Liquidity, and profitability.

43
Q

What does profitability depend on?

A

The degree of risk attached to a loan.

44
Q

Why is a non secured loan risky?

A

If a customer defaults on a payment, the bank can’t recover money.

45
Q

What are the assets of a bank ordered from liquidity to profitability?

A

Cash, BOE Balances, Money lent to other banks, Bills, Investments in Gov bonds, Advances - credit/loans, Non-current assets - premises.

46
Q

What does contractionary monetary policy aim to do?

A

Shift AD to the left.

47
Q

What does the extent of price fall depend on?

A

The shape of the AS curve.

48
Q

What do lower interest rates do to the economy?

A

Discourage saving, stimulate borrowing, encourage investment, cause exchange rate to fall, makes exports more price competitive.

49
Q

What does a flat AS curve cause?

A

An increase of real output.

50
Q

What does a steep AS curve cause?

A

Inflation.

51
Q

What is the Transmission mechanism?

A

A chain of how change in interest rates affects different parts of the economy.

52
Q

What does the official rate affect?

A

Market Rate, Asset prices, confidence, exchange rate.

53
Q

What does market rate, asset prices, confidence and exchange rate affect?

A

Domestic demand, net external demand.

54
Q

What is the equation for total demand?

A

Domestic demand + net external demand.

55
Q

What does total demand affect?

A

Domestic inflationary pressure.

56
Q

What do interest rate changes affect?

A

The affordability of mortgages, which changes the price of assets.

57
Q

What is the impact of an increase in Bank rates?

A

Rate increases, market price increases, domestic demand decreases, fall in total demand, less inflationary pressure, stagflation.

58
Q

What is the impact on the exchange rate?

A

Increase commercial rates available, higher rates mean overseas investors want to place their money in UK accounts. Increase in demand for sterling.

59
Q

Why is there a time lag between a change in the bank rate, and the rate of inflation?

A

Output is affected within one year, but inflation occurs after a lag of two years.

60
Q

What is Quantitative Easing?

A

A monetary policy which aims to increase liquidity of financial system, by purchasing long term government bonds, Stimulating economic growth, encouraging banks to lend or invest more freely.

61
Q

What was QE1?

A

£200 billion of QE between March 2009 and January 2010.

62
Q

What was QE2?

A

£125 billion of QE between October 2012 and May 2014.

63
Q

What was QE3?

A

£50 billion between July 2012 and October 2012.

64
Q

What was QE4?

A

£60 billion from August 2016.

65
Q

What was QE5?

A

£450 billion between March and November 2020.

66
Q

What has the total QE been since 2009?

A

£895 billion.

67
Q

What is forward guidance?

A

Attempts to send signals to financial markets and businesses about interest rate policies in months and years ahead.

68
Q

What does forward guidance aim to do?

A

Increase credibility of monetary policy, ease financial markets, enables people to feel more confident in the long term.

69
Q

What does forward guidance mean for interest rates?

A

Helps convert low interest rates in the short term into lower rates in the long term.

Macro Year 1 (15 decks)

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