4.4 monetary policy Flashcards
What is the definition of monetary policy
Decisions on the money supply, the rate of interest and the exchange rate taken to influence aggregate demand
What does ‘money supply’ mean
The total value of money available in an economy at a point of time.
What does ‘interest rate’ mean
The cost of borrowing money
What do higher interest rates do
More expensive to borrow money, hence people are discouraged from doing so therefore investments decrease
Saving becomes more attractive and consumer expenditure starts to fall.
What do lower interest rates do
Less expensive to borrow money, hence people are encouraged from doing so and therefore investments increase.
Saving becomes less attractive and consumer expenditure starts to rise.
How does the monetary authority (Central Bank) influence the interest rate and exchange rate
Interest rate - changes the interest rates of borrowing between the central bank and commercial banks. These will then influence the interest rate provided by commercial banks on loans and deposits to individuals and businesses.
exchange rate - Changes interest on its bonds and securities.
What is expansionary monetary policy
Involves increasing in the money supply and/or the reducing the interest rate, resulting in an increase aggregate demand
How can governments implement expansionary monetary policies
Reduce interest rates
Increase money supply
Quantitative easing
benefits of expansionary monetary policy
Increase in consumer spending and borrowing
Business invest more since they have to pay less on their borrowings
Increase in economic activity
Economic growth - higher output as demand increases hence supply
Rise in employment
When are expansionary monetary polices used
May be used during recession
What is quantitative easing
Governments use newly created money to buy up financial assets held by banks
Eg: govt and cooperate bonds
Why do banks buy the financial bonds in the first place
disadv
Attractive interest rates until they mature
Disadv:
Money is tied up for many years.
What does quantitative easing allow banks to do
When government buys back those bonds they increase the quantity of money banks have available to lend to people and firms
What are contractionary monetary policies
cuts in the money supply and/or rises in the rate of interest designed to reduce aggregate demand
How can government implement contractionary monetary policies
(there are 3)
Increase interest rates
Reduce money supply
Offer government bonds to banks at attractive interest rates. This ties up the banks money, reducing the ability of the bank to lend money.
