3.2 - Signposting

Question 1

How the Central Bank Reduces Interest Rates (Opposite for a Rate Rise)

Answer 1

1. Reduce the reserve requirement
2. Reduce the repo/bank rate (discount rate)
3. Buy bonds using open market operations

Question 2

Expansionary Monetary Policy - The Transmission Mechanism (Opposite for Contractionary)

Answer 2

1. A cut in interest rates will reduce the cost of borrowing
2. A cut in interest rate reduces the rate of return on savings
3. A cut in interest rates will reduce the monthly payments for those with tracker or variable rate mortgages
4. A cut in interest rates will reduce the cost of borrowing for firms
5. If UK interest rates fall, there will be ‘hot money’ outflows

Question 3

What does Expansionary Monetary Policy do for Growth and Unemployment?

Answer 3

1. Growth increases
2. Unemployment decreases

Question 4

Expansionary Monetary Policy and LRAS

Answer 4

1. A cut in interest rates reduce the cost of borrowing for firms enabling them to reach their hurdle more easily (the required rate of return for investment projects to go ahead). This would therefore increase LRAS

Question 5

Expansionary Monetary Policy Cons

Answer 5

1. Can result in demand-pull inflation
2. Interest rates have a lower bound when the economy is liquidity trap
3. It would have a large negative impact on savers who will receive a lower rate of retun on their assets

Question 6

Contractionary Monetary Policy Pros

Answer 6

1. To control inflation
2. To protect against credit/asset bubbles and systemic risk in banking sector
3. To make housing more affordable
4. Promote more sustainable lending and borrowing
5. Encourages saving and investment
6. Improvements in the current account balance

Question 7

Contractionary Monetary Policy Cons

Answer 7

1. Potential shock to the economy
2. Indebted economic agents could ‘fall of a cliff’
3. Higher interest rates could detract borrowing for investment
4. Higher interest rates will strengthen the exchange rate and could deteriorate the current account position

Question 8

Expansionary Monetary Policy Evaluation (Opposite for Contractionary)

Answer 8

1. Effect depends on the initial level of economic activity
2. Depends on the size of the interest rate cut
3. The level of consumer and business confidence in the economy
4. The length of time lags for interest rates (monetary policy) having an effect on the economy
5. On the initial level of interest rates
6. Whether banks are willing to lend and willing to pass on the full rate cut

Question 9

Quantitative Easing Cons

Answer 9

1. Inflation in the economy can increase (demand-pull inflation)
2. Banks may still not be willing to lend
3. QE drives wealth inequality
4. Negative impact on savers