12.3 Central Banks And Monetary Policy Flashcards
What is a central bank?
A national bank that provides financial and banking services for a country’s gov and banking system as well as implementing the govs monetary policy and issuing currency
What are the two key functions of a central bank?
Help gov maintain macroeconomic stability
Bring about financial stability in the monetary system
What is the govs inflation targer
2%
How can price stability be achieved
Through the bank acting as a lender of last resort to the banking system +the central bank monitoring and regulating the financial system
What is the lender of last resort .
The readiness of the central bank to extend loans to banks that are solvent but have short term-liquidity problems-stops a crisis in the financial system
What is a kit function of the Bank of England
Function of implementing monetary policy on behalf of the gov
What is monetary policy ?
Part of economic policy that attempts to achieve the govs macro objectives using monetary instruments such as controls over bank lending and the rate of interest
What is a policy objective
Target the Bank of England aims to hit
What is a policy instrument
Is the tool of control used to try achieve the objective
What can policy objectives be divided into?
Ultimate and intermediate objectives
What do policy objectives split people into?
Seperwte those that directly affect the supply or Jew deposits that the commercial banks can create those that influence the creation of bank deposits by affecting the demand of loans and credit
What is the monetary policy Committe
Part of the Bank of England which Implements UK monetary policy
Gov sets monetary policy targete which the MPC try and achieve
What are monetary policy instruments?
The tools used to achieve the objectives of monetary policy
Bank of England taking action to influence interest rates supply of Koenig and credit and the exchange rate
What is the bank rate
The rate of interest the Bank of England pays to commercial banks on their deposits held in the Bank of England
What does monetary policy actually do?
Used to manage the level of AD in the economy
How does fiscal policy affect AD
Changes gov spending
How does monetary policy change AD?
Changes G, C,I and X-m
What are the factors considered by the monetary policy committee when setting bank rate?
+
-current rate of inflation
-existence of inflationary or deflationary pressure
-consumer and business confidence
-economy’s growth rate
Levels of unemployment and employment
When happens if inflation is 1% above or below target
Bank of England must write a letter to the chancellor explaining what happened
What is contractionary monetary policy?
Uses higher inters rates to decrease AD and shift the AD curve to the left
Diagram for how increased interest rates shift AD to the left
What are the 3 main ways a increased interest rate decreases AD
-reduce household consumption (incentive to save)
-reduce business investment (higher borrowing costs)
-affects imports and exports
How does changes in interest rates affect imports and exports?
+interest rate: increases demand for pounds by attracting capital flows into the currency, causes the pounds exchange rate to rise makes pound less competitive internationally
-interest rate: triggers a capital outflow in the balance of payments. Increase of supply of pounds leads to a fall in exchange rates exports become more price competitive and the current account of the balance of payments improves. aD increases
What is expansionary monetary policy?
Uses lower intrest rates to increase AD
Diagram how a reduced interest rate increases AD
What does the Bank of England argue that changes in bank rate affect?
AD and inflation through a number of channels which form the transmission mechanism of bank rate policy
Diagram for the transmission mechanism of interest rate policy leads to inflation
What causes domestic demand?
Spending, saving and investment behaviour of individuals and firms within the economy
Do changes in AD affect inflationary pressures
Yes because if an increase exceeds the economy’s abi,it’s to increase the supply of output it creates demand-pull inflationary pressures
What is the estimated time lag from a bank rate change and the resuming change of inflation
2 yrs
What is the bank rate floor called?
The zero lower bound
What does the liquidity trap describe?
A situation when cutting intrest rates below certain level fails to stimulate consumer spending
Quantitative easing?
When the Bank of England buys assets, usually gov bonds with the Monet the bank has created electronicslly
What is the main form of unconventional monetary policy
Quantitive easing
What is another name for quantitive easing?
Asset purchase scheme
What is the thinking behind quantitative easing?
Financial institutions (banks,pensions,insurance companies) who sell bonds to the Bank of England will lend the newly created Monet to businesses and individuals, the latter can invest and spend more hopefully increasing growth
What is the principal aim of quantitative easing?
Increase money supply directly
Quantitive easing easy explanation
Increases deposits Bank of England hoods increasing their ability to lend it to the general public
Diagram for how QE is utilised
What are the main affects of direct injections of Monet into the economy (buying gilts)
-sellers of assets have more money to spend
-banks have more reserves
-
When was Quantitive easing first introduced by the Bank of England
March 2009
When were the bouts of quantitative easing ?
March 2009 QE1
October 2011 EQ2
Feb 2012 EQ3
What is forward guidance
Attempts to send signals to financial markets buisinesses and individuals about the Bank of Englands interest rate policy in the months and years ahead so economic agents are not surprised from a sudden change of policy
What is the 2nd unconventional part of monetary policy
Forward guidance
What is the aim of forward guidance
Increase the credibility of monetary policy
(Calm uncertainty in otherwise jittery markets)
How does a fall in interest rates weaken the pound
Causes financial capital to flow out of the pound and into other currencies non search of better rates or return
Reduces demand for pound and increases it supply on exchange markets causing its exchange rate to fall
What are the two ways changes in exports and import prices brought about by falling exchange rates lead to inflation
Increase prices of imported food and consumer goods -increases UK rate of inflation increased prices of raw materials(cost push inflation)
-reduces uk export prices while raising price of imports
