Monetary Policy Flashcards
What is monetary policy?
the manipulation of the price and availability of money within an economy to achieve economic policy objectives
What is the main focus of monetary policy?
level of interest rates
What are other aspects of monetary policy?
- size of the money supply, availability of credit and exchange rate of currency
What is the key aim of monetery policy?
achieve the governments inflation target (rate of 2%) per year
How is the 2% inflation target achieved?
changes to the bank rate
Who decides the bank rate ?
Monetery policy committee
What areas are considered in deciding bank rates?
- consumer spending and confidence
- business investment and confidence
- fiscal policy
- the exchange rate
- commodity prices
- unemployment and labour market conditions
What will happen if there are increased chances of inflation in near future?
- members of MPC will vote to raise interest rates, in order to decrease AD and cause less pressure on demand pull inflation
What will the effect on the economy be from rising bank rates?
- lower levels of borrowing by consumers
- higher monthly repayments for mortgages
- increased incentives to save
- lower business investment
- rise in exchange raye
How long do changes in interest rates take to work through the economy?
1- 2 years
What are time lags?
gap in time between changes in interest rates and seeing the effect in the economy
what will be the result of lower AD from using interest rates?
- higher unemployment from lack of spending
- lower short term economic growth
- growth of supply side of economy is limited due to lack of investment
- lower tax revenue collected
- reduced level of exports due to likely rise in exchange rate
What are limitations of using interest rates to control the economy?
- time lags
- uncertain effects (cannot be sure of impacts)
- when interest rates are low, further cuts may not be possible
- changes have to be large to have an impact
How will a rise in interest rates likely to effect exchange rate?
- rise in value of pound
Why will higher interest rates increases the value of the pound?
higher interest rate attracts hot money (flows of short term money) into the currency due to high returns
- higher demand for the pound will increase its value, leads to downward pressure on cost push inflation
How will a rise in the exchange rate effect other parts of the economy?
- a rise in ER will make exports become less price competitive abroad
- a fall in ER will boost exports leading to more jobs in export sector
- fall in ER will lead to higher inflation as imports more expensive
What is the liquidity trap?
occurs when a period of very low interest rates and a high amount of cash balances held by households and businesses fails to stimulate aggregate demand.
What are the two main parts of the liquidity trap?
- risk averse commerical banks
- private sector business and consumers
Effect of liquidity trap on commerical banks?
- Required to hold more capital
- Charging a risk premium on new loans especially to business customers
effect on private businesses and consumers?
- Low on confidence
- Focused on cutting debt rather than taking out new loans
Explain liquidity trap?
- extreme effect of monetary policy. It is a situation in which the general public is prepared to hold on to whatever amount of money is supplied, at a given rate of interest. They do so because of the fear of adverse events like deflation, war.
