4) Evaluating Monetary Policy in the 2020’s - MMT

Question 1

What are the main tools of monetary policy, as used in the 21st century by the major developed economy central banks?

Answer 1

They include: interest rate changes, QE and inflation rate targeting

Question 2

When was monetary policy very fashionable?

Answer 2

For the last quarter of the 20th century

Question 3

Who popularised the idea of monetary policy?

Answer 3

A group of economists (monetarists) led by Milton Friedman, popularise the idea that controlling the money supply and ensuring low, stable rates of inflation was the key to long run economic growth

Question 4

Did governments like the idea of monetary policy?

Answer 4

Many governments rigidly followed the ideas of monetarists

Question 5

What was the problem in 2008/09?

Answer 5

After the financial crash (2008/9) a new problem emerged, the inflation rate was too low, with serious risk of deflation. Interest rates were cut to almost zero but the existence of a liquidity trap in many developed countries undermined the usefulness of low interest rates

Question 6

What is a liquidity trap?

Answer 6

Where consumers and investors hoard cash rather than spending or investing it even when interest rates are low, studying?? Efforts by economic policymakers to stimulate economic growth

Question 7

In 2008/9 what did they do to overcome the effects of the financial crash ?

Answer 7

Central banks began to use QE

Question 8

How was monetary policy used to combat the 2020 global pandemic?

Answer 8

This sparked extensive use of QE by the central banks, aiming to compensate for the collapse in the economic activity caused by Covid. The economic effects of the pandemic were still ongoing in 2022 but were then exacerbated by a new crisis, Russia’s invasion of Ukraine

Question 9

What cause a new inflationary crisis in 2022?

Answer 9

The economic effects of the pandemic were still ongoing in 2022 but were then exacerbated by a new crisis, Russia’s invasion of Ukraine. A combination of general supply-side shortages from Covid and severe disruption to the supply of key resources like, oil, gas and grain (caused by war) created a new inflationary crisis, levels reaching 11% in the UK, 9 percentage points higher than the target rate

Question 10

What were the central banks response to this inflationary surge in 2022?

Answer 10

Was to increase interest rates, between 2021 and mid 2023, the Bank of England increased the Bank rate on 12 separate occasions. From a starting point of 0.5% the bank rate moved to 4.5%, the highest it has been in several decades.

Question 11

Did increasing interest rates in response to the inflationary surge in 2022 do anything?

Answer 11

Despite increasing interest rates, the UK inflation rate remained stubbornly in double figures, still over 10% in May 2023

Question 12

why has the contractionary monetary policy of raising interest rates not worked to reduce inflation for 2022/23?

Answer 12

The Bank of England believes that it’s working but just taking longer than usual, the long time lag is seen as a traditional weakness of monetary policy

Question 13

How long have high inflation rates (of 2021/22/23) maintained despite contractionary monetary policy?

Answer 13

High inflation started to take a grip in late 2021, 18 months after that was still far too high

Question 14

What could be a reason for time lag for contractionary monetary policy in 2022/23? (Mortgages)

Answer 14

Might be that many of those targets by the higher interest rates have not yet felt the pinch, eg about 80% off mortgage holders were on fixed rate mortgages meaning their repayment levels had not yet been affected and their RDI was relatively unchanged

Question 15

What could be a reason for time lag for contractionary monetary policy in 2022/23? (Mortgages, explain using a diagram)

Answer 15

Therefore AD has not sufficiently shifted to the left and price levels hadn’t fallen

Question 16

What could be a reason for time lag for contractionary monetary policy in 2022/23? (Labour)

Answer 16

In 2023, the UK economy has faced a severe shortage of Labour meaning that the private sector wages increased strongly, again protecting AD

Question 17

What could be a reason for time lag for contractionary monetary policy in 2022/23? (Pensions)

Answer 17

The government had fully index-linked pension payments so, despite the high inflation, many older households were not worse off

Question 18

Which groups in society have QE benefited?

Answer 18

The extensive QE conducted in the last decade, significantly boosted asset prices, many retirees and higher income households may actually have been better off

Question 19

What could be a reason for time lag for contractionary monetary policy in 2022/23? (Wealthy and retired)

Answer 19

The extensive QE conducted in the last decade, significantly boosted asset prices, many retirees and higher income households may actually have been better off. Their sourcing represents a high % of overall consumption in the economy so AD did not fall by much and therefore the price level was not coming down

Question 20

Why does the Bank of England believe increasing interest rates will work in reducing inflation?

Answer 20

The firmly believe that the higher rates will eventually impact upon AD, making saving more attractive than consumption, helping to bring prices under control

Question 21

What are the reasons for the time lag in the contractionary monetary policy used in 2022/23?

Answer 21

• Mortgages/interest rates not felt
• shortage of Labour
  -fully index-linked pension payments
• extensive QE, increasing inequality and not reducing AD by much

Question 22

What is the differing opinion on QE?

Answer 22

Other economists differ, believing the Bank of England to be misguided in their approach to interest rate rises. One branch of economists think that the Bank actually caused this high inflation themselves, through overuse of QE meaning that there was way too much money circulating the economy. Combined with supply-side issues mentioned previously this created an excess demand for goods and services. This could only be effectively tackled by abolishing the policy of QE and restricting the future money supply

Question 23

Why do economists have differing opinions to the Bank of England, believing it to be misguided in their approach to interest rate rises? (2 things)

Answer 23

• disagree with QE
  -lies in supply-side factors

Question 24

Why do economists differ with the Bank of England increasing interest rates, creating contractionary monetary policy? (Supply)

Answer 24

The argument is that higher interest rates will never address the inflation surge as this inflation (2022/23) is dominated by cost-push factors, not demand factors. Therefore the solution lies in shifting the SRAS cover to the right, perhaps by the use of government subsidies (eg for small business energy bills), paid for by windfall taxes on the few giant energy companies whose profits have soared.

Question 25

Judgement: Is monetary policy successfully tracking inflation in the UK?

Answer 25

It is still too early to judge whether monetary policy is successfully tackling inflation in the UK. However there is no doubt that it is taking a long time to take full effect and that other (UK specific) factors may be limiting its effectiveness

Question 26

What are the possible reasons for shortages in Labour in 2023?

Answer 26

Not working due to health issues, aging population, long term covid, back and neck issues due to working from home, immigration bills (smaller workforce due to Brexit), SRAS and LRAS shifting to the left meaning wages increase