British Monetary Policy Flashcards
Week 6
1
Q
What are the two macroeconomic schools of thought that evaluate Government intervention?
A
- KEYNESIANISM: Active approach
- Left to itself, free markets are unstable, hence fiscal ‘Demand management’ policy should be used to regulate flows of investmen t
- MONETARISM: Passive apporach
- Belief that fiscal effects are only temporary and thus monetary policy is more effective in controling demand an inflation
2
Q
What do the Bank of England do to affect monetary policy?
A
- BoEngland have the aim to influence the rate of interest and money supply to achieve growth/inflation targets
- Changes in the SRIR affects spending, saving and investment behaviour of households
3
Q
What are the key macroeconomic objectives (1945-)?
A
- Economic growth
- Full employment
- Stable prices
- BoP position
4
Q
Why is Inflation bad?
A
- Cost of inflation is worse if inflation is unanticipated
- Imposes costs of adjusting prices (menu costs)
- Harm those on fixed salaries
- Creates uncertainty, detering investment
- Loss of international competition and the devaluing exchange rate
5
Q
Name some approaches to monetary policiy?
A
- Discretion: Policy makers intervene by taking an active approach to speed up adjustment
- Rules: A credit rule to intervene at how to respond at each level (πe will go down given certainty)
6
Q
Name the central bank of objectives. How has this changed over time?
A
- LR Price stability: controls growth of MS
- Influencing the business cycle: controls by varying IR
- Objectives are often in conflict, so they must priortise
- TARGETS- (1970-1985) Rates of monetary aggregation, (1985-1992) Nominal Exchange rate, (1992-) Inflation Rate Targeting
- Managed via instruments (r and Ms)
7
Q
Name some of the Bank of England features
A
- Produced Bank of England notes & coins & bank reserves
- Exclusive legal mandate to control MS
- Banker’s bank
- Serves as a bank to the Government
8
Q
What is M0?
A
- The sum of currency in circulation + reserves
- Reserves don’t make up that much
9
Q
How do banks make money?
A
- Initial deposit leads to a succession of loans, paid in the form of deposits
- While the Bank keeps a certain x% of the deposits as reserves (new loan = 100-x%)
- Each chain acts as a MONEY MULTIPLIER
- Central Banks can influence this process by setting a ‘Reserve Requirement’ or influencing the rate at which banks can borrow at
10
Q
How can the BoE manipulate interest rates in order to keep variables constant? How would this look graphically?
A
- QoM target- C.B uses tools to ensure a fixed level of MS [at Mo1] with supply SQ (|), increasing r1 -> r2
- PoM target- C.B uses tools to ensure a fixed rate of interest [at r1] with supply SP (-), increasing Mo1 -> Mo2
- Demand for money is downward sloping
11
Q
How do Open Market Operations work?
A
- C.B are monopolist producers of the base, can increase/decrease Mo in circulation
- Buying assets from financial sector and increase Mo
- Sell their assets to financial sector and remove their assets to decrease Mo
- At a fixed IR, C.B can inject/withdraw to achieve their target
- To achieve a lower IR, BoE use expansionary M.P to increase the demand for Government bonds, reduce the yield, increase the price and therefore reduce the IR
- This has no effect on amount of MS
12
Q
How did monetary policy look in the 1970s?
A
- Bretton Woods fell apart in 1973
- Oil price shocks (1973/74) and (1979/80)
- This cerated stagflation- Keynesianism could not deal with it (Increasing G didn’t reduce U)
- “Money mattered”- (wasn’t prioritised until 1976)
13
Q
Give some characteristics of the monetarist phase (1979-1985)
A
- Following turmoil of 1970s, search for a nominal framework that provided an anchor for price level
- Targets for aggregation introduced [began at M3/M4, then M0]
14
Q
What happened during the Medium Term financing strategy?
A
- 1980: Announcement of MTFS, setting 4 year targets of broad money: PSBR
- M3 seen as the most reliable indicator, so IR rose to 17% but M3 didn’t stay
- This, paired with North Sea Oil issue, made the £ increase massively
- Therefore, this harmed the manufacturing sector, making output fall and unemployment rise
- Unemployment peaked at 3m
- M3 was actually unreliable, Net exports fell
15
Q
What happened after the medium term financial strategy? What were the main reasons for failure?
A
- Illustrated that tight monetarism didn’t always work
- Following the squeeze in 1982, π, r and £ all fell
- Lawson also used the fiscal stimulus to boost aggregate demand
- MTFS was overhauled, M0 and M1 became included
- Reasons: Distress borrowing from ailing firms in recession, financial dereg increases access to credit and erratic M3 behaviour
