Monetary Policy Flashcards
Define monetary Policy?
involves changes in interest rates, the supply of money and credit and exchange rates to influence the economy
What is expansionary monetary policy?
- AD rises
- fall in nominal and real interest rates
- measures to expand supply of credit
- depreciation of exchange rate
Breifly explain deflationary monetary policy?
- lower AD
- higher interest rates on lonas and savings
- tightening of credit supply
- appreciation of the exchange rate
TRANSMISSION MECHANISM
What is the transmission mechanism of moneatry policy?
ways in which changes in interest rates influence aggregate demand, output and prices
GIve three logical chain of reasoning for rising of interest rates?
- more expensive to borrow –> lower incentive
- higher reward for saving –> greater incentive to save
- rates rise on variable rate mortgages –> less discretionary income
all lead to fall in consumer spending, falling AD and fall in inflationary pressure
WHat is the MPC
monetary policy committee
- sets interest rates monthly
WHat is the FPC?
financial policiy commitee
- safeguarding financial stability
What are interest rates?
reward for saving and the cost for borrowing expressed as a percentage of the money saved or borrowed
Name the six types of interest rates in modern economy ?
- bank loans
- mortgages
- credit card rates
- payday loans
- corporate loans
- government bonds
What does the bank of england set policy interest rates consistent with?
the need to meet an inflation target of consumer price inflation of 2%
Give some examples of what interest rates are set on?
- GDP growth and spare capacity
- bank lending
- equity markets
- consumer and business confidence
- unemployment and employment data
What is a reduction in interest rates an example of?
expansionary monetary policy
What will lower interest rates do in economy?
- cost of servicing loans/ debt is lower (boosts spending power)
- higher consumer confidence
- discretionary income rises
- higher business investment
- housing market is effected
- cheaper currency increasing exports
Impact of lower interest rates on demand side of economy?
- reduces savings ratio and makes borrowing more attractive so consumption rises
- increases real national output
- creates employment
Impact of lower interest rates on supply side?
- can stimulate businesses investment into capital process to improve their productivity and efficiency
- investment componant of AD, so shifts outwards
- productive capacity increases, higher growth and employment
What is the downside of lower interest rates/
- banks less willing to lend
- low consumer confidence
- huge levels of debt
- ## falling or slowing rise asset process
Give a logical chain of reasoning for higher interest rates?
MPC raises interest rates –> signals tighter MP –> market interest rates increase –> cost of borrowing rises –> main effect will be through mortgages –> slowdown in housing market –> contraction in retail credit –> currency appreciation –> makes Uk exports more expensive in overseas market
What will investers do if the exchange rate increases and what is the impact?
- move money to the Uk in order to get the best return –> HOT MONEY
- increse demand for UK pound increases the exchange rate
- exports less attractive, imports more
- worsens balance of payments on current account
When does a liquidity trap occurs?
- low interest rates and high amount of cash balances in the economy fail to stimulate aggregate demand
What are some reasons for a liquidity trap/
- risk adverse commercial banks
- low confidence in private sector businesses and consumers
- low interest elasticity of demand
What are the three main ways that interest rates decrease demand?
- reduce household spending
- reduce business investment
- changes in interest rates affect exports and imports via exchange rate
Evaluation points for monetary policy?
- time lags in the economy
- not an exact science, humans are unpredictable
- doesnt work in isolation
