3.6 Monetary policy

Question 1

Definition of monetary policy

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 (AD).

Question 2

Expansionary monetary policy

Answer 2

Lowering the interest rate or a rise in the money supply. To increase aggregate demand in the economy to try and increase output and employment.

Question 3

Contractionary monetary policy

Answer 3

Increasing the interest rate or a fall in the monetary supply. in order to decrease aggregate demand in the economy and lower inflation.

Question 4

Quantitative easing

Answer 4

When the bank rate is already too low and the BOE cant use it affectively to affect AD.
BOE buys corporate bonds or government bonds.
This leads to an increase in the price of these bonds which means that the yield that holders of these bonds get goes down.
This lower interest on bonds feeds through to lower interest rates for households and businesses helping to boost spending.

Question 5

Effects of monetary policy

Answer 5

Firms will increase output to meet this increased AD leading to SR economic growth.
As firms expand they will hire more workers, leading to a decrease in unemployment.
If the economy is operating close to the productive capacity there will be demand pull inflation.

Question 6

Evaluating monetary policy

Answer 6

1) Size of the change and how long its expected to last
2) Time-lags if interest rate changes take a while to have an effect on spending
3) If banks and other lenders don’t change their interest rates in response to a BOE change in interest rate.
4) If consumers and producers aren’t confident about future economic performance they will save and not borrow.
5) If fiscal policy is used at the same time they outcomes will be more effective.
6) The bigger the multiplier effect. The bigger the effect of higher consumption and investment on real GDP.