Monetary Policy

Question 1

What is the impact of interest rate change on inflation?

Answer 1

As interest rates rise, borrowing becomes expensive which may lead to a decrease in consumption hence, a decrease in aggregate demand and so an increase in savings could result in a decrease in inflation.

As interest rates fall, borrowing becomes cheaper which may lead to an increase in consumption or investment hence, an increase in aggregate demand which may result in an increase in inflation and economic growth.

Question 2

What is the impact of interest rate changes on unemployment?

Answer 2

If interest rates fall, there may be an increase in demand for loans leading to spending by firms to increase which increases aggregate demand. Firms would respond by producing more goods and services which could result in more recruitment of staff hence, unemployment falls.

Question 3

What is the impact of interest rate changes on economic growth?

Answer 3

The base rates set by central banks can be set 0 because it stimulates more economic growth; this means monetary policy may be used to help get an economy out of recession.

Question 4

What is the impact of interest rate changes on the current balance?

Answer 4

If interest rates rise, exchange rate may also rise which means exports become more expensive, imports become cheaper which may result in worsening of the current balance

Question 5

What’s the link between interest rates, exchange rates and balance of payments?

Answer 5

When interest rates fall, it can lead to a decrease in demand for a country’s currency, which can cause a depreciation of the exchange rate. A weaker currency can make exports more competitive and cheaper, potentially increasing exports and decreasing imports, which can improve the current account balance.

However, the relationship between interest rates, exchange rates, and the current account is complex and can be influenced by various other factors, such as economic growth and government policies. Additionally, lower interest rates may encourage borrowing and investment, which can stimulate domestic demand for imports, potentially having a negative impact on the current account

Question 6

How do the changes in interest rates affect consumers?

Answer 6

1. if they decrease, demand for loans rise meaning consumers are more likely to borrow money
2. if they decrease, consumers with a mortgage may find that their payments will fall which means they have more money to spend which increases aggregate demand
3. if they increase, consumers try reduce borrowing because it becomes expensive resulting in demand for goods to fall.
4. if they increase, mortgage payments rise hence, households will have less disposable incomes to spend and so they’ll have to cut their expenditure.

Question 7

How do the changes in interest rates affect firms? if they decrease and increase

Answer 7

if they decrease,
- interest payments on current borrowings fall too which helps boost profits as costs will be lower.
- Levels of business confidence rise which may stimulate more investment and so returns on the investments are likely to be higher
- exchange rate falls as well which means prices of exports become cheaper and demand will rise for them leading to firms benefitting (as they sell more goods & services). Prices of imports rise meaning consumers & firms will buy fewer. An increase in exports and a decrease in imports will further result in a positive impact on the current account

if they rise,
- it will increase costs meaning it will lower profits and reduce business confidence resulting in investments to fall

Question 8

What does tightening or loosening monetary policy mean?

Answer 8

Tightening monetary policy means increasing interest rates which generally leads to a decrease in aggregate demand

Loosening monetary policy means decreasing interest rates which generally leads to an increase in aggregate demand

Question 9

Define the monetary policy

Answer 9

The use of interest rates and money supply to control aggregate demand

Question 10

Define quantitative easing

Answer 10

Buying of financial assets from commercial banks resulting in a flow of money from the central bank to the commercial bank.