3.6 Monetary Policy

Question 1

What is the definition of monetary policy

Answer 1

Monetary Policy is the changing of interest rates and money supply by the central bank to influence economic activity

Question 2

What is expansionary monetary policy?

Answer 2

• the bank rate decreases
• the money supply increases
• borrowing becomes less costly so people spend more boosting AS and AD
• reward for savings decreases so people are more willing to spend
• mortgage payments decrease so house purchases are easier

Question 3

What is contractionary monetary policy?

Answer 3

• bank rate increases
• money supply decreases
• borrowing becomes harder so people borrow less, decreasing AS and leading to lower economic growth
• reward for savings increases so people spend less
• mortgage payments increase so people find it harder to buy a home

Question 4

How can expansionary monetary policy affect inflation?

Answer 4

• increased money supply means people can borrow more easily
• this means people spend more increasing AS and AD and therefore SREC
• if AD exceeds the productive capacity of the economy then this can lead to demand pull inflation

Question 5

What can expansionary monetary policy do to the current account

Answer 5

• because producers and consumers can borrow more due to lower interest rates
• this means they will import more goods widening the current account deficit or reducing the surplus

Question 6

What is the keynsian Liquidity Trap for monetary policy?

Answer 6

• The idea that after a certain point interest rates can lose their effect/ interest rates have a lower bound
• interest rates have no effect after a point

Question 7

What can expansionary monetary policy do to savers?

Answer 7

• If inflation is higher than interest rate then savers can be harmed, also less savings can have a larger risk
• living standards will decrease

Question 8

What is a bad aspect of monetary policy about time

Answer 8

• Monetary Policy effects have time lags and take time

Question 9

How can you evaluate monetary policy

Answer 9

1. Consumer Confidence + Business Confidence - need to confident about economy to consume and invest otherwise it will not work
2. Bank willingness to pass on bank rate cut - or if they do not lend if there is a crisis or lack of confidence
3. Size of the rate cut - higher cuts will be more effective

Question 10

What is a policy conflict with monetary policy?

Answer 10

• not all of the 4 main macroeconomic objectives can be positively influenced, for example expansionary monetary policy may negatively affect inflation, but help unemployment and economic growth