5.3 Monetary policy

Question 1

Definition of monetary policy

Answer 1

Monetary policy is a deliberate attempt by the CENTRAL BANK to regulate the money supply or manipulate interest rates or exchange rate to influence the level of economic activity in order to achieve macroeconomic goals

Question 2

Tools of monetary policy

Answer 2

1. Interest rate
2. Money supply

Question 3

Reduce Interest rate (vice versa)

Answer 3

1. Saving becomes less attractive
2. Cost of borrowing lower
3. Consumption expenditure may increase
4. Investment increase
5. AD rises
6. Lower unemployment
7. Exchange rate depreciates
8. Export > import

Question 4

How to Increase Money supply ( lower interest rates)

Answer 4

1. Buying government securities
2. Reduce Minimum reserve requirement (MRR)
3. Quantitative easing
   - a form of EMP
   - inject money directly into the economy by buying government and corporate bonds

Question 6

Strengths of monetary policy

Answer 6

1. Quick implementation
2. No political constraints
3. No crowding out
4. Ability to adjust interest rates incrementally

Question 7

Weakness of monetary policy

Answer 7

1. Time lags
2. Possible ineffectiveness in recession
   - in a severe recession, banks may be unwilling to lend
   - if firms or consumers are pessimistic about future economic conditions, they may avoid taking loans