Chapter 31 Flashcards
What is monetary policy
Decision made by the government regarding monetary values such as money supply and interest rates
What is the money supply
is the quantity of money that is in circulation in the economy
What 4 functions does money perform
Medium of exchange
Store of value
Unit of account
Standard of deferred payment
What is the interest rate the opportunity cost of
Holding money
What is the central bank
the banker to the government, they act as a banker to commercial banks and regulate the financial system. They issue coins and banknotes.
What is the UKs central bank
The bank of england
The transmission mechanism of monetary policy
the channel by which monetary policy affects aggregate demand
What is monetary policy used for
to control the money flow of the economy.
What does it mean when interest rates are low
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
What does it mean when interest rates are high
The reward for saving is high and the cost of borrowing s high. Usually done during periods of high inflation.
What can high-interest rates attract
Hot money flows
What is quantitative easing
Used to stimulate economy when monetary policy is no longer effective (can cause inflation). It pumps money into economy
When is quantitative easing used
when inflation is low and it is not possible to lower interest rates further
What are limitations of monetary policy
- 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
What is the liquidity trap
This is where the change in quantity supply of money does not change the interest rate.
How does quantitative easing work
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
What is a loose monetary policy
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.
What is a tight monetary policy
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.
What are the effects of higher interest rates AD
- Reduced consumer spending
- Increased propensity to save
- Investment is decreased (hurts UK long-run potential)
- ## Exchange rate appreciation (decreased AD)
What are the effects of higher interest rates on Supply
- Less investment in capital - so decrease in LRAS (productive potential).
- Capital stock ages and becomes less productive and efficient
Evaluation of higher interest rates on supply
- 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.
