monetary policy

Question 1

define monetary policy

Answer 1

use of interest rates and the money supply to control aggregate demand in the economy in a given time period
money supply: amount of money circulating in the economy
interest rates: cost of borrowing and reward for saving

Question 2

impact on macro objectives

Answer 2

inflation: contractionary reduce inflation by raising interest rate money supply grows less quickly as borrowing is more expensive firms and consumers take less loans reduce aggregate demand limit price increases
unemployment: expansionary lower interest rates increase loans spending/investment increases reward for saving less increasing aggregate demand firms react by producing more g&s to meet therefore they recruit more staff reducing unemployment

expansionary to stimulate economy - lower encourages spending/investment increase business confidence, interest on current borrowing fall reducing cost increasing profit large portion of investment funded by borrowing return are likely to be higher, increase demand for exports and reduced demand for imports benefitting domestic firms and increase aggregate demand

current account: tradeoff as higher interest reduce aggregate demand reduce spending on imports but higher exchange rate means exports more expensive and imports cheaper worsen CA balance

depend on income elasticity of imports - if elastic higher interest rates would reduce demand improve current balance
strength of the link between interest and exchange rates - stronger worsen current balance higher rates
price elasticity of demand for imports and exports: both price elastic interest rise exchange rate rises worsen the balance

Question 3

quantitative easing

Answer 3

central banks buy financial assets e.g. government bonds from commercial banks which results in a flow of money from central to commercial banks so they can make more loans to firms and consumers increasing money supply increasing aggregate demand

Question 4

role of central bank

Answer 4

implementing gov monetary policy
lender to commercial banks last resort
controlling inflation stabilising nation’s currency
setting interest rates - base rates influencing rest of rates in the country

Question 5

depends on

Answer 5

time lag
consumer/business confidence
rate of cut
trade-off between current account deficit