Macro 12 - Monetary Policy Flashcards
Monetary policy - definition
>Policies which attempt to influence demand and other macroeconomic goals in an economy through influencing the money supply, primarily through the manipulation of interest rates.
Monetary policy summary
>Monetary policy aims to influence AD by bringing about changes in the money supply.
>This may involve manipulation of bank interest rates, manipulation of exchange rates, quantitative easing, making credit more or less easy to access and regulation or deregulation of the banking sector.
>In the UK, monetary policy is primarily managed by the Bank of England (the central bank for the UK).
>The government only provides oversight and guidance in terms of macroeconomic aims but the BoE makes most decisions regarding monetary policy independently of the government.
Monetary policy may involve…
>This may involve manipulation of bank interest rates, manipulation of exchange rates, quantitative easing, making credit more or less easy to access and regulation or deregulation of the banking sector.
The exchange rate and AD
>The pound has a floating exchange rate.
>This means the price of the pound in relation to other currencies is determined by market forces and not directly influenced by the government or Bank of England.
>This is in contrast to fixed or managed exchange rates which are in some way controlled by govs or central banks.
>However, other countries choose to manipulate exchange rates and monetary policy implemented by the BoE can have an impact on the price of the pound.
>If the gov. causes a rise or fall in exchange rate it influences net exports and so AD too.
What do exchange rates have a direct impact on?
(x-m)
What happens when the value of a currency falls?
>Exports become cheaper and so domestic goods will become more competitive.
>Demand for exports increases.
>Imports will become more expensive so demand for imports falls.
>The current account deficit decreases and surplus increases (if the Marshall-Learner condition holds true).
>If exports increase and imports decrease then AD will increase causing economic growth.
>Unemployment may also be reduced through the creation of more jobs from economic growth.
>Inflation may rise if demand for imports is price inelastic.
>Increased import prices can also cause cost-push inflation.
>The impact on inflation depends on the P.E.D for imports and domestic goods.
What does the impact of inflation depend upon?
>The P.E.D for imports and domestic goods.
Interest rates and exchange rates
>To transfer funds from bank accounts in one country to those in another, the money must be exchanged between currencies. This means demand and supply for the pound will be affected by the popularity of savings accounts in the UK and abroad.
>Households and investors will move their money anywhere it will bring them the highest returns.
>This means they will be quick to buy stocks and shares or gov. bonds or transfer their money to bank accounts their income from investment/saving will be relatively high.
>These flows are known as hot money (flows).
The role of central banks vs commercial and investment banks.
>While commercial and investment banks are independently and privately owned institutions that provide a service for the public and businesses, central banks operate to help the gov. meet macroeconomic and are often publicly owned.
>While commercial and investment banks perform the important role of allowing firms and households to borrow, save money and provide financial advice to their customers, central banks aim to maintain a stable economy.
>Commercial and investment banks are motivated by profit, central banks are motivated to meet government objectives.
What is the UK’s Central Bank?
>The Bank of England.
>It’s owned by the UK treasury.
What are the key roles of the central bank?
- They are a LENDER OF LAST RESORT to both commercial banks and the government.
- In charge of CONTROLLING THE EXCHANGE RATE.
- Set the BASE RATE OF INTEREST. This enables them to indirectly influence the rates of interest commercial banks can charge,
- REGULATE commercial banks to ensure they are both RESPONSIBLE (not making risky investments and loans) and ETHICAL (not taking advantage of the customer). Regulations can also make it less/more easy to qualify for a loan.
- The MONETARY POLICY COMMITTEE - FORECAST, FORWARD GUIDANCE.
- CREATES DIGITALLY/PRINTS MONEY to directly influence the money supply and in turn, level of demand in the economy.
Monetary Policy Committee info
>An organisation that works within the Bank of England to decide base rate of interest to reach the government’s 2% target.
>They also forecast inflation and growth.
>The BoE provides forwards guidance, revealing to firms and households what they intend to do in the future, which helps make businesses more confident.
Forward guidance
>When a central bank reveals to firms and households what they intend to do in the future, which helps make businesses more confident.
Central Bank - definition
>A central bank is an independent national authority that conducts monetary policy, regulates banks, and provides financial services including economic research.
Commercial Bank - definition
>Is a type of financial institution that accepts deposits, offers checking account services, makes various loans, and offers basic financial products like certificates of deposits (CDs) and savings accounts to individuals and small businesses.
