Central Banks and Monetary Policy

Question 1

What is the bank rate?

Answer 1

interest rate set by the BofE when lending to commerical banks or financial insitutions

Question 2

What are the two key functions of the central bank?

Answer 2

• help gov maintain macroeconomic stability
• to bring about financial stability in the monetary system

Question 3

How will the central bank effect money supply?

Answer 3

• influencing broad money rather then narrow money

Question 4

How does BofE effect broad money?

Answer 4

• agrees reserve requirements individually with each bank
• BofE involved in open market operations
• alters interest rates

Question 5

What happens if money supply increases quickly?

Answer 5

inflationary pressure

Question 6

What are conventional monetary instrument examples?

Answer 6

• interest rate
• supply of money and credit
• exchange rate

Question 7

LEARN MTM

Question 8

What determines effectiveness of monetary policy in the UK?

Answer 8

• accuracy of inflation targets
• time lags
• interest elasticity of demand (responsiveness to interest rates)
• inflation expectations
• levels of gov debt
• liquidity trap

Question 9

What is the liquidity trap?

Answer 9

occurs when low interest rates and high amount of cash balances in the economy fail to stimulate aggregate demand

Question 10

reasons for liquidity trap?

Answer 10

• risk adverse commercial banks
• low business and consumer confidence
• low interest elasticity of demand

Question 11

What is quantitative easing?

Answer 11

where Bank creates new money to buy government and corporate bonds in the open market

Question 12

Explain QE process?

Answer 12

• BoE creates new money electronically to buy financial assets
• increase in demand for bonds mean the interest rate on the bond decreases
• banks now have a surplus of cash from bond sale which can be lend to individuals and businesses
• banks can now pay lower interest rate when new bonds issued
• commerical banks should have more cash available and be able to access funds at cheaper rate which they can lend
• new lending will increase bank deposits improving funding position and makes them more willing to lend

Question 13

What is the funding for lending scheme?

Answer 13

• incentivises banks and building societies to boost lending
• BofE lets commercial banks borrow funds cheaply, banks pass this on to firms
• should boost spending in economy

Question 14

What is forward guidance?

Answer 14

use of communication about future central bank actions to influence present behaviour

Question 15

What is aim of forward guidance?

Answer 15

influence financial decisions of households and firms by letting them know what to expect from interest rates

Question 16

What is quantitative tightening?

Answer 16

contractionary monetary policy applied by central bank to decrease the amount of liquidity in economy

Question 17

How does QT work?

Answer 17

letting the bonds and other securities it has purchased reach maturity. When this happens, the Treasury department removes them from its cash balances, and thus the money it has “created” effectively disappears.