5.3 Monetary policy Flashcards
What is monetary policy?
The use of monetary policy tools by a central bank to influence the money supply and aggregate demand to achieve certain macroeconomic aims.
What are the three tools of monetary policy?
Interest Rates, Exchange Rates and credit regulations
What is money supply?
The notes and coins in circulation of an economy
Who is responsible for conducting monetary policy in most countries?
The central bank
What are the two types of monetary policy?
Expansionary monetary policy and contractionary monetary policy.
What happens when the central bank raises interest rates?
Borrowing becomes more expensive, reward for saving is higher, reducing consumption and investment.
What happens when the central bank lowers interest rates?
Borrowing becomes cheaper, reward of saving is less, increasing consumption and investment.
How does the government devalue their currency?
The government buys other currencies using their own, which is usually printed, which increases the supply of their own currency in the forex which lowers the value of it
What happens after the government devalues their currency?
Price of their exports falls, which leads to more sales of exports which ultimately increases AD as their balance of trade becomes more positive
Why does the exchange rate devaluation depend on PED?
If their exports are inelastic it is not good as the rise in sales will be a lot less which means revenue is negative and AD doesn’t rise
What is the reserve assets ratio?
Commercial banks are required to hold a certain amount of cash deposits at the central bank this amount is the reserve asset ratio
What happens when the central bank increases the reserve asset ratio?
Commercial banks have less money to lend out, the money supply decreases and borrowing decreases. As a result C decreases, AD lowers
What is an expansionary monetary policy?
An monetary policy aimed to expand the economy by manipulating money to increase AD
What is an contractionary monetary policy?
An monetary policy aimed to contract the economy by manipulating money to decrease AD
What are the main 2 advantages of monetary policy?
- Achieve macroeconomic aims
- Quick to implement
What are the main 3 disadvantages of monetary policy?
- Cannot be targeted at specific industries
- Long lag time
- Macroeconomic aims conflict with each other
