Monetary Policy

Question 1

What is monetary policy?

Answer 1

the manipulation of the price and availability of money within an economy to achieve economic policy objectives

Question 2

What is the main focus of monetary policy?

Answer 2

level of interest rates

Question 3

What are other aspects of monetary policy?

Answer 3

• size of the money supply, availability of credit and exchange rate of currency

Question 4

What is the key aim of monetery policy?

Answer 4

achieve the governments inflation target (rate of 2%) per year

Question 5

How is the 2% inflation target achieved?

Answer 5

changes to the bank rate

Question 6

Who decides the bank rate ?

Answer 6

Monetery policy committee

Question 7

What areas are considered in deciding bank rates?

Answer 7

• consumer spending and confidence
• business investment and confidence
• fiscal policy
• the exchange rate
• commodity prices
• unemployment and labour market conditions

Question 8

What will happen if there are increased chances of inflation in near future?

Answer 8

• members of MPC will vote to raise interest rates, in order to decrease AD and cause less pressure on demand pull inflation

Question 9

What will the effect on the economy be from rising bank rates?

Answer 9

• lower levels of borrowing by consumers
• higher monthly repayments for mortgages
• increased incentives to save
• lower business investment
• rise in exchange raye

Question 10

How long do changes in interest rates take to work through the economy?

Answer 10

1- 2 years

Question 11

What are time lags?

Answer 11

gap in time between changes in interest rates and seeing the effect in the economy

Question 12

what will be the result of lower AD from using interest rates?

Answer 12

• 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

Question 13

What are limitations of using interest rates to control the economy?

Answer 13

• 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

Question 14

How will a rise in interest rates likely to effect exchange rate?

Answer 14

• rise in value of pound

Question 15

Why will higher interest rates increases the value of the pound?

Answer 15

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

Question 16

How will a rise in the exchange rate effect other parts of the economy?

Answer 16

• 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

Question 17

What is the liquidity trap?

Answer 17

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.

Question 18

What are the two main parts of the liquidity trap?

Answer 18

• risk averse commerical banks

- private sector business and consumers

Question 19

Effect of liquidity trap on commerical banks?

Answer 19

• Required to hold more capital

- Charging a risk premium on new loans especially to business customers

Question 20

effect on private businesses and consumers?

Answer 20

• Low on confidence

- Focused on cutting debt rather than taking out new loans

Question 21

Explain liquidity trap?

Answer 21

• 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.