2.6 Flashcards
What are the 4 aspects of money that a government will be concerned about?
-The Rate of Inflation
-The Exchange Rate
-The Supply of Money
-The Interest Rate
Monetary policy involves
Monetary policy involves changes in interest rates, the supply of money & credit and exchange rates to influence the economy
An interest rate is
An interest rate is the reward for saving and the cost of borrowing expressed as a percentage of the money saved or borrowed
Different type of interest rates
- Interest rates on savings in bank and other accounts
- Borrowing interest rates
-Mortgage interest rates (housing loans)
-Credit card interest rates and pay-day loans
-Interest rates on government and corporate bonds
Transmission Mechanism of Monetary Policy
- Change in market interest rates-B of E changes base rates which impacts on interest rates for borrowing and savings
- Impact on demand-AD shifts due to change in Spending, Investment and Exports
- Effect on output, jobs & investment-Multiplier impact on Consumption, jobs and investment
- Real GDP and Price Inflation-Output and prices will change depending on AS
(It can take between 12-24 months for the full effects on real GDP and the inflation rate after a change in policy interest rates)
Quantitative Easing (QE)
Quantitative easing is a process whereby a Central Bank, such as the Bank of England, purchases existing government bonds (gilts) in order to pump money directly into the financial system.
Quantitative easing (QE) is regarded as a last resort to stimulate spending in an economy when interest rates are so low that they no longer stimulate the economy.
The Bank of England uses QE to increase the supply of money in the banking system and encourage banks to lend at cheaper interest rates – especially to small & medium sized businesses
Expansionary Monetary Policy
-Fall in nominal and real interest rates
-Measures to expand supply of credit
-Depreciation of the exchange rate
Deflationary Monetary Policy
-Higher interest rates on loans and savings
-Tightening of credit supply (loans harder to get)
-Appreciation of the exchange rate
How Quantitative Easing (QE) is meant to work
-Central bank creates money electronically - Adds money to their balance sheet
-This money is used to buy financial assets - Mainly the purchase of government bonds
-More demand leads to higher prices for assets e.g. bond prices. Rise in price of bonds leads to a lower yield (%) on government bonds
-Can feed through to fall in long term interest rates e.g. mortgages and corporate bonds
-Lower interest rates and increased cash in the banking system should stimulate the economy
Limits to the Effects of Low Interest Rates
-Banks have been reluctant to lend
-Some interest rates e.g. credit card rates have actually risen
-Low Confidence means consumption and investment is low
-High amounts of personal debt holds back demand
-Asset prices bubble due to low interest rates
-Falling real incomes for millions of savers
Monetary policies
-Liquidity trap- this occurs when a cut in interest rates fail to stimulate economic activity
-Cost push inflation
-Exchange rates
-Time lags
Fiscal terms
-Balanced budget
-budget deficit
-buget surplus
-crowding out
-expansionary fiscal policy
-income tax
-national debt
-progressive tax
Types if fiscal polices
-Discretionary- refers to policies which are decided and implemented by on off policies changes made by the gov
-Automatic- tax and spending stabilisers that slows down fall in AD when the economy enters a recession, and retaining the AD when the economy speeds up
Fiscal stance
-Neutral- shown if gov runs a balanced budget
-Reflationary- when gov has budget deficit
-Deflationary- when gov runs budget surplus
What is the fiscal multiplier
-An increase in consumer spending due to gov spending
