Chapter 27: Monetary policy

Question 1

Monetary policy

Answer 1

Decisions on the money supply, the rate of interest, and the exchange rate

Question 2

Changes in money supply

Answer 2

• Can increase the money supply by printing more money, buying back bonds, or encouraging banks to lend more
• If money supply is increased, there is likely to be an increase in consumer spending and investment - likely to increase output

Question 3

Changes in rate of interest

Answer 3

• Rise in interest rate is likely to reduce demand by lowering consumer spending and investment
• Households or firms who borrowed in the past will have to pay more interest on their loans reducing the amount of money they have to spend
• More expensive for households and firms to borrow to finance their spending
• Increases the incentive to save - opportunity cost of investment and spending increased
• Firms also have less incentive to invest as they expect consumption to be lower
• Some households may save more
• Some may spend more as they earn more interest
• Those who save are less likely to spend any extra money than borrowers are
• May reduce aggregate demand by encouraging a rise in the foreign exchange rate
• Lower net exports by causing a rise in the price of exports and a fall in the price of imports

Question 4

Changes in exchange rate

Answer 4

• Governmen may instruct central bank to chang edirectrly the country’s foreign exchange rate to try to influence it to move in a particular direction
• Government may want the price of the exchange rate to fall eg. encourage a rise in exports

Question 5

Expansionary monetary policy

Answer 5

• Increase economic growth rate and reduce unemployment
• Reducing rate of interest or increasing the supply of money

Question 6

Contractionary monetary policy

Answer 6

• Reduce aggregate demand and theupward pressure on prices
• Increase rate of interest or reduce the growth in money supply