Monetary Policy

Question 1

What is monetary policy

Answer 1

Monetary policy is a form of demand side policy when the government manipulates the countries monetary variables in order to stimulate aggregate demand and achieve macroeconomic objectives

Question 2

What are the instruments of monetary policy

Answer 2

• interest rates
• money supply

Question 3

What are the two types of monetary policy

Answer 3

• expansionary (increase aggregate demand)
• deflationary (decrease aggregate demand)

Question 4

What happens to instruments of monetary policy in expansionary monetary policy

Answer 4

• decrease in real and nominal interest rates (borrowing is easier and cheaper)
• increase in credit supply (quantitative easing)
• depreciation of exchange rate (managed exchange rate)

Question 5

What happens to the instruments in contractionsry monetary policy

Answer 5

• rise in interest rates for loans and savings
• tightening of credit supply (harder to squire a loan)
• appreciation in exchange rate (effect of rise in interest rates)

Question 6

What is the monetary transmission mechanism of monetary policy (expansionary)

Answer 6

• Easier to obtain credit from banks
• borrowing increases the disposable income of consumers leading to increase in consumer confidence
• household marginal propensity to save decreases leading to increase consumer spending -> aggregate demand increases
• wealth effects also occur as during times of low interest rates demand for mortgages and houses increase leading to higher house prices and increased wealth of house owners -> consumer confidence increases leading to increased consumption
• cheaper to borrow for businesses so increased investment which increases aggregate demand
• depreciation in exchange rate as the rate of return decreases which decreases incentive to save in the uk, demand for pound decreases -> depreciation which increase export competitiveness which also increases Ad

Question 7

What is the monetary mechanism of monetary policy

Answer 7

• higher interest rates increase the marginal propensity to save which leads to Lowe consumption
• higher interest rates lead to higher mortgage payments which decreases disposable income fo home owners -> decrease consumer confidence -> lower consumption
• causes an appreciation in exchange rate as demand for pounds increases due to higher rate of return on savings -> decreases export comeptiveness

Question 8

What are some evaluation of manipulating interest rates

Answer 8

• bringing interest rates very low leads to excess growth in aggregate demand which can lead to demand pull inflation
• can lead to a liquidity trap -> consumer and firms may not respond positively to this cheap money which limits spending as they believe interest rates will increase
• makes it harder to buy a house for first time buyers although owners benefit -> increased inequality
• increasing the consumer confidence could e,ad to increased demand for imports -> current account deficit

Question 9

If interest rates are ineffective what may government resort to

Answer 9

Quantitive easing

Question 10

What can be argued about the impact of a depreciation of the exchange rate of aggregate demand

Answer 10

• may not lead to increase in Ad
• according to j curve and Marshall Lerner condition