lesson 9: monetary policy Flashcards
what do you always link monetary policy back to?
the wider economy and macroeconomic objectives
what are the two main functions of the bank of england?
macroeconomic stability
bringing about financial stability
how many people in the MPC?
8
4 economists
4 bank of england employees
1 governor
what does the MPC do?
meet 8 times a year to review evidence on the performance of the economy and indicators of changes in inflationary pressure
what is the target rate for the MPC with inflation?
2% with CPI
whats the relationship between bonds and yields?
inverse
Wagner’s Law
demand for public sector goods is income elastic and so an increase in incomes will lead to an even bigger increase in public expenditure
what is the bank rate?
the interest rate the bank of england charges when lending money to commercial banks
what happens when the bank rate increases?
borrowing becomes more expensive so banks raise their interest rates for businesses and people
what happens when the bank rate decreases?
borrowing becomes cheaper, so banks lower their interest rates making loans more affordable
what are the impacts of low interest rates?
discourages savings, encourages borrowing, more money available for consumption —> also lowers mortgage payments, homeowners have more money, leads to more consumption
investment increases as firms borrow to invest
hot money flows out, demand for the currency falls, lowers price of exports, increases price of imports, uk firms are more internationally competitive
what happens to commercial banks if the MPC raises the bank rate?
MPC raises bank rate —> commercial banks raise interest rates —> raising cost of borrowing —> less consumption + investment —> reducing AD
this is because for changes in the bank rate have to be passed onto the commercial banking system to be effective
what are the impacts of a high interest rate?
high rates encourage saving and discourages borrowing —> mortgage bills increase —> consumption falls
firms see higher costs and delay investment
hot money flows in —> rising demand —> currency strengthens —> exports are less competitive —> so its cheaper to import
what is LIBOR?
London interbank offered rate of interest
banks lend to each other here
its set everyday based upon demand and supply of funds as banks lend to each other
what is QE?
the bank creates new electronic money by the bank purchasing assets providing liquidity and in theory means they lend more and boost AD
expansionary monetary policy
when QE boosts asset prices what does it lead to?
QE boosts asset prices —> fall in long term interest rates —> increases AD
what is forward guidance?
the idea of telling financial markets, businesses and individuals what the bank is thinking about future interest rate policy
what is it called raising rates from close to zero?
normalisation
trying to return to normal
what happens to borrowing and saving when there is an increase in interest rates?
increased cost of borrowing
greater return from savings
