19)demand Management (2): Monetary Policy Flashcards
What does interest rates mean
⚫️cost of borrowing
⚫️reward of savings
What does monetary policy mean
⚫️use of interest rate and money supply
➡️to manipulate the level of AD in the economy
⚫️controlled by the bank of England
What other roles do the bank of England have
⚫UKs central bank
⚫️decides on the amount of money in circulation
➡️and issues bank notes
⚫️banker of the Government
⚫️ banker to the banking system
➡️will act as lender of last resort when bankrupt
⚫️manages the countries gold and foreign currency reserves
⚫️regulates the UKs banking and financial system
What does base rate mean
the minimum rate of borrowing in the economy
How long does it take for interest rate to fully feed through into the economy
12-24 months
What piece of info does the MPC need to consider to help it to predict inflation in 12-24 months
⚫️unemployment statistics
⚫️sales of UK exports
⚫️government spending plans
⚫️wage rate rises
⚫️consumer and business confidence surveys
⚫️cost of raw materials
⚫️asset prices
Why is unemployment statistics help it to predict inflation in 12-24 months
⚫️if unemployment is low
➡️this could lead to cost-push pressures
➡️as firms have to offer higher wages to attract workers
Why is sales of UK exports help it to predict inflation in 12-24 months
⚫️An increase in demand for UK exports
➡️will increase AD
➡️putting pressure on price level
Why is government spending plan help it to predict inflation in 12-24 months
⚫️an increase in government spending
➡️increase AD
➡️increase the price level
Why is a rise in wage rate help it to predict inflation in 12-24 months
⚫️a large increase in national minimum wage
➡️lead to increase cost of production
➡️shifting AS to the left
➡️causing cost-push inflation
Why will consumer and business confidence survey help it to predict inflation in 12-24 months
⚫️if consumers or firms worried about the future
➡️they may cut down on their spending plans
➡️leading to a reduction in C and I
➡️a fall in AD
➡️a reduction in price level
Why is the cost of raw materials help it to predict inflation in 12-24 months
⚫️a rise in oil of gas prices
➡️lead to cost-push inflation
➡️due to increase costs of production for firms
Why is the asset prices help it to predict inflation in 12-24 months
⚫️a decrease in house prices ➡️mean people who own such asset will feel poorer ➡️wealth effect ➡️may cut back spending plans ➡leading to fall in C ➡️decrease in AD ➡️reduce price level
What are all interest rate decisions based on
Forecasts of the future
What will happen if data suggests that forecast inflation will rise above the 2% target
⚫️MPC will consider tightening monetary policy
➡️by increasing interest rates
What will happen if data suggests that forecast inflation will fall below the 2% target
⚫️MPC will consider loosening monetary policy
➡️by reducing interest rates
What does tight MPC mean
An increase in interest rate
What will happen if theres an increase in interest rate
⚫️leads to leakage of ➡️consumption ➡investment ➡️net export ⚫️AD will shift to the left
⚫️if they forecast that inflation rising above target
➡️the MPC will use this to slow growth of the economy
What is a loose monetary policy
Reduction in the interest rate
What will happen if interest rate decreases
⚫️lead to injection of extra ➡️investment ➡️consumption ➡️net export ⚫️AD will shift to the right
⚫️if MPC forecast that inflation is falling below target
➡theyll use this to boost the economy
What does the interest rate have an impact on
⚫️exchange rate
⚫️firms
⚫️savers
⚫️borrowers
How does the interest rate increasing have an impact on the borrowers
⚫️mortgage interest payments rise
⚫️households with mortgages have less money to spend
⚫️wealth effect ➡️demand for houses falls ➡️house prices fall ➡️home owners feel less worthy ➡️consumption falls ➡️AD shifts to the left ➡️price level and inflation falls
How does the interest rate increasing have an impact on the savers
➡️saving becomes more attractive
➡️more income is saved
➡️less is spend
➡️consumption decreases
➡️AD shifts to left
➡️price and inflation decreases
How does the interest rate increasing have an impact on the exchange rate
➡️uk becomes more attractive place to save
➡️hot money flows into the UK
➡️demand for £ increases
➡️value of the £ increases
➡️UK exports become more expensive
➡️net export decreases
➡️AD shifts to the left
➡️price level and inflation decreases
What is the impact of tight monetary policy on AD and inflation
➡️AD decreases
➡️inflation decreases
What is the impact of loose monetary policy on AD and inflation
➡️AD will increase
➡️inflation will increase
Why is monetary policy effective
⚫️interest rate can respond quickly to the problems in the economy
⚫️changes in the interest rate have large impacts on consumption and investment
⚫️long run impact on investment and AS
⚫️An independant bank will be tough on inflation
How is interest rate responding quickly to problems in the economy effective for monetary policy
⚫️MPC of bank of England meets monthly
➡️can raise/lower interest rate immediately as it wishes
❎fiscal policy on the other hand, is changed once a year on budget day
How is changes in interest rate having a large impact on consumption and investment effective for monetary policy
⚫️has large impact on AD and economy
⚫️changes in any demand management policies like fiscal policy and monetary policy
➡️have big impact on AD and economy
➡️because of multiplier effect
➡️describe multiplier with example n formula
How is long run impact on investment and AS effective for monetary policy
⚫️if interest rate decreases
➡️AD will increase in short run
➡️as investment increases
➡️this could also shift AS in the long run
➡️as capital stock is updated
➡️becomes more productive
➡️increasing quality of nations factor of production and its ability to produce goods
What are the limitations of monetary policy
➡️time lags
➡️magnitude
➡️fixed rate mortgages and loans
Why is time lags a limitation of monetary policy
⚫️changes in the interest rate takes a long time to feed through ➡️consumption ➡️investment ➡️AD ➡️economy transmission mechanism ➡️takes between 12-24 months
⚫️thus bank of England
➡️emphasises regular small changes in interest rate
Why is the magnitude a limitation of the monetary police
⚫️impact on economy depends on magnitude on interest rate
➡️MPC usually raises/lowers rates by only 0.25%
➡️unlikely to have major impact on economy
➡️on its own in the short run
Why is fixed rate mortgages and loans a limitation of monetary policy
⚫️interest rate changes may not have much effect on
➡️households that have fixed rate mortgages and loans
⚫️fixed rate mortgages
➡️becoming increasingly popular in Uk over last decade
⚫️household on variable rate mortgages and loans
➡️will be immediately affected when interest rate changes
