3.6 Monetary Policy

Question 1

Monetary policy definition

Answer 1

The manipulation of the money supply or interest rates by the central bank in order to influence the level of total spending in the economy

Question 2

Expansionary monetary policy

Answer 2

Lowering of interest rates or increasing the money supply, to increase aggregate demand, increasing output and employment

Question 3

Contractionary monetary policy

Answer 3

Increase in interest rates or a fall in the money supply, decrease aggregate demand and decrease inflation

Question 4

Consequences of expansionary monetary policy

Answer 4

• firms will increase output, to meet increased AD, leading to short-run economic growth
• due to increased output they might need to hire more workers, unemployment decreases
• if economy is already operating near productive capacity then, demand-pull inflation EVAL: depends if firms increase investment in order to increase productive capacity

Question 5

Evaluating monetary policy

Answer 5

Depends on:

• size of the change in interest rates
• time lags, if interest rate changes take a long time to have an affect on spending, AD will not rise in line with a decrease in interest rates
• commercial bank interest rates, if banks and other lenders do not change there interest rates in line with the BOE base rate then borrowing and saving will not be affected
• confidence, if consumers and firms do not have confidence they are more likely to save then borrow