3) Monetary Policy (3) QE and Other tools - MMT

Question 1

By manipulating interest rates what does this do?

Answer 1

The Bank of England aim to control the supply of money, either increasing it (expansionary monetary policy) or decreasing it (Contractionary monetary policy)

Question 2

What does monetary policy hope to effect?

Answer 2

The level of AD and the price level

Question 3

Why does the Bank of England not literally print more money or less money (contractionary monetary policy)?

Answer 3

• It is very outdated, cash is now such a small pay of overall spending, by 2022 cash was only used for 10% of the value of all payments in the UK
• the reputation of extra bank notes to solve economic problems never really recovered from its disastrous use by the German government in 1922/23, when it created hyperinflation, ultimately leading to the Nazi’s gaining power in Germany

Question 4

Why is there hyperinflation?

Answer 4

Too much money chasing too few goods

Question 5

What is the most important alternative to bank rate changes?

Answer 5

The policy of Quantitative Easing

Question 6

Is Quantitative Easing Expansionary or Contractionary?

Answer 6

Expansionary

Question 7

When was it widely used?

Answer 7

To counter the threat of deflation from 2010-2015

Question 8

What does QE involve the Bank of England doing?

Answer 8

Creating money digitally, brand new money that had not previously existed, by just (figuratively) pressing a button!

Question 9

What is the extra money in quantitative easing used for?

Answer 9

The extra money is then used to buy government bonds from a wide range of financial institutions but particularly banks, doing this injected cash into the banking system

Question 10

What is the hype with this new injected cash into the banking system?

Answer 10

The hope is that this cash can be used by banks as a basis for creating new loans to different economic agents

Question 11

What is the hope of the result of QE?

Answer 11

Bank of England hope to increase AD in the economy and get the price level higher, if the target inflation rate is low, QE might be effective in raising it

Question 12

What is another intentional consequence of QE other than countering inflation?

Answer 12

It lowers interest rates

Question 13

What are interest rates basically?

Answer 13

Interest rates (r) is basically the price you pay to borrow money

Question 14

What are interest rates determined by?

Answer 14

Demand and supply of money

Question 15

In the interest rate diagram, what do we assume is independent?

Answer 15

Money supply is actually independent of interest rates as money supply is determined by the Bank of England

Question 16

How does the Demand for money look on the interest rates diagram?

Answer 16

Demand for money comes from the economic agents; like all D curves this slopes downwards, implying that the economic agents demand more money at lower rates of interest

Question 17

Why is the money supply (MS) curve inelastic?

Answer 17

The supply of money is fixed by the Bank of England: therefore the MS curve is perfectly inelastic, fixed at Q1,Q2 or whatever

Question 18

How is QE displayed on the interest rates diagram?

Answer 18

That if the Bank of England use QE to increase the money supply, MS shifts to the right from MS1 to MS2 meaning the equilibrium interest rate will fall

Question 19

How did QE unintentionally increase inequality?

Answer 19

A consequence from the widespread use of QE by central banks in the 2010’s, it caused a large surge in the value of assets other than money. This is because the return from saving money was poor at low interest rates whilst the cost of other assets was also lower than before, due to low interest rates. This increase in asset prices greatly benefited those on high incomes, exacerbating income and wealth inequalities

Question 20

What are the other tools that the Bank of England is in Monetary Policy? (3 ways)

Answer 20

1) Change the inflation target
2) Change the reserve ratio
3) Manipulate the exchange rate

Question 21

What is an example of changing the inflation target?

Answer 21

If inflation is too low they could increase the target from 2% to 3%

Question 22

How would inflation targeting effect the economy?

Answer 22

This would change inflationary expectations in the economy

Question 23

What would happen if the Bank of England increased the inflation target?

Answer 23

This would change inflationary expectations, workers would claim higher wage deals which in turn would drive up prices

Question 24

If inflation was too high, how would the Bank of England change the inflation target?

Answer 24

They would lower the target rate

Question 25

Who sets the reserve ratio?

Answer 25

The reserve ratio is a regulation set by a central bank which commercial banks have to follow

Question 26

What does the reserve ratio mean?

Answer 26

It is a regulation set by a central bank which commercial banks have to follow, it requires them to keep a certain % of their deposits in cash

Question 27

If the reserve was set to 1% by the Bank of England, what does this mean?

Answer 27

Then every commercial bank would need to keep 1% of the value of their deposits in cash

Question 28

What does raising the reserve ratio to 2% mean?

Answer 28

Would mean that banks need to keep more cash meaning they can give out less in new loans; lowering (or abolishing) the ratio would increase the ability of banks to create new money

Question 29

How does the central bank manipulate the exchange rate?

Answer 29

This is especially important where a country has a fixed exchange rate, the central bank buys and sells its own currency on the open market with the objective of sustaining the level they want

Question 30

How would central banks manipulate the exchange rate if it is being forced downwards?

Answer 30

They increase demand for their own currency by buying it (using their reserves of foreign currency)

Question 31

How would central banks manipulate the exchange rate if it is under upward pressure?

Answer 31

They increase supply of their own currency by demanding more foreign reserves. The People’s Bank of China use this approach to manage the value of the Yuan