3.6 Monetary Policy Flashcards
What is monetary policy?
It is a government policy that aims to control the total supply of money in an economy, particularly to achieve price stability.
What are the two tools monetary policy uses?
- Interest rates
- Quantitative easing
How does monetary policy control interest rates?
The Bank of England sets the interest rate to influence commercial bank rates.
How does reducing interest rates effect economic objectives?
It increases economic growth and employment.
How does increasing interest rates effect economic objectives?
It reduces inflation and creates a healthier balance of payments.
How does lowering interest rates affect economic growth and employment through consumers?
Since the opportunity cost of borrowing is lower, consumers have more disposable income and spending. Due to increased demand for goods, more people need to be employed to provide these.
How does lowering interest rates affect economic growth and employment through firms?
Firms also borrow more as there is a lower opportunity cost. This money can be invested into new machinery which will increase output. As firms expand, they will need to employ more workers.
How does lowering interest rates affect economic growth and employment through exchange rates?
Lower interest rates lead to a fall in demand for the pound, so exports will be cheaper. This leads to greater demand for UK goods leading to more output. More need to be employed to meet the rising demand.
How does increasing interest rates affect inflation through consumers?
Borrowing becomes more expensive and those with a variable mortgage pay more. As a result, consumption falls. Shops lower their prices to attract customers and inflation decreases.
How does increasing interest rates affect inflation through firms?
The cost of firms borrowing rises so they spend less on capital goods. As a result, demand for their product falls and inflation is lowered.
How does increasing interest rates affect inflation through exchange rates?
If interest rates are higher, the UK exchange rate is higher. This makes imports cheaper, so output decreases in the UK and demand falls.
What is the effect of lowered interest rates on consumer spending and what does this depend on?
If interest rates fall, consumer spending is likely to increase. However, this depends on the size of change, how large the mortgage sector is and whether consumers (such as retired) rely on savings as income.
What is the effect of lowered interest rates (because of monetary policy) on borrowing and what does this depend on?
Consumers borrow more as they can buy expensive items or take out a mortgage since interest payments are lowered. However, if they lack confidence in the economy they may not borrow.
What is the effect of higher interest rates on saving and what does this depend on?
Generally, consumers will save more due to higher returns. However, if the change in rates is small, inflation is higher than the real rate of interest and if consumers (retired) rely on savings as income, they may choose to spend.
What are the effects of monetary policy on investment?
If interest rates rise, then the cost of borrowing for businesses will be higher. As a result, firms will not invest. Other factors such as state of the economy and competition can affect investment.
