Chapter 31

Question 1

What is monetary policy

Answer 1

Decision made by the government regarding monetary values such as money supply and interest rates

Question 2

What is the money supply

Answer 2

is the quantity of money that is in circulation in the economy

Question 3

What 4 functions does money perform

Answer 3

Medium of exchange
Store of value
Unit of account
Standard of deferred payment

Question 4

What is the interest rate the opportunity cost of

Answer 4

Holding money

Question 5

What is the central bank

Answer 5

the banker to the government, they act as a banker to commercial banks and regulate the financial system. They issue coins and banknotes.

Question 6

What is the UKs central bank

Answer 6

The bank of england

Question 7

The transmission mechanism of monetary policy

Answer 7

the channel by which monetary policy affects aggregate demand

Question 8

What is monetary policy used for

Answer 8

to control the money flow of the economy.

Question 9

What does it mean when interest rates are low

Answer 9

the reward for saving is low and the cost of borrowing is low, this means consumers and firms can access credit cheaply which encourages spending and investment. Used to stimulate economic growth and AD

Question 10

What does it mean when interest rates are high

Answer 10

The reward for saving is high and the cost of borrowing s high. Usually done during periods of high inflation.

Question 11

What can high-interest rates attract

Answer 11

Hot money flows

Question 12

What is quantitative easing

Answer 12

Used to stimulate economy when monetary policy is no longer effective (can cause inflation). It pumps money into economy

Question 13

When is quantitative easing used

Answer 13

when inflation is low and it is not possible to lower interest rates further

Question 14

What are limitations of monetary policy

Answer 14

• Banks might not pass the base rate on to consumers so it might not have intended effect
• Even if cost of borrowing is low consumers might be unwilling to lend as banks are more risk aware after 2008 crash
• Monetary policy effects depend on firm and consumer confidence
• time lags (takes time to be passed onto consumers with fixed rates)
• effects parts the economy differently
• liquidity trap

Question 15

What is the liquidity trap

Answer 15

This is where the change in quantity supply of money does not change the interest rate.

Question 16

How does quantitative easing work

Answer 16

The central bank will purchase assets, electronically pushing money into the economy. This is when interest is low and increased money supply still doesn’t push the economy out of sluggish growth.
This also works backwards such as selling these assets to take money out of the economy

Question 17

What is a loose monetary policy

Answer 17

If the Bank of England anticipates inflation falling below the government’s target of 2% and economic growth is sluggish, or the economy is facing a recession. They are likely to cut interest rates. Lower interest rates, in theory, should stimulate economic activity. This is because lower interest rates reduce borrowing costs. This increases the disposable income of consumers with mortgage interest payments and should encourage spending.

Question 18

What is a tight monetary policy

Answer 18

If the Bank feels the economy is growing too quickly and inflation is expected to exceed the government’s target, then they are likely to increase interest rates to reduce the rate of economic growth and reduce inflationary pressures. In this case, a rise in interest rates causes a fall in consumer spending and investment leading to lower inflation.

Question 19

What are the effects of higher interest rates AD

Answer 19

• Reduced consumer spending
• Increased propensity to save
• Investment is decreased (hurts UK long-run potential)
• ## Exchange rate appreciation (decreased AD)

Question 20

What are the effects of higher interest rates on Supply

Answer 20

• Less investment in capital - so decrease in LRAS (productive potential).
• Capital stock ages and becomes less productive and efficient

Question 21

Evaluation of higher interest rates on supply

Answer 21

• Allows UK to import capital at a cheaper price
• Improve business confidence as higher interest rates help to control inflation
• More people save so its easier for business to access financing.