Monetary policy Flashcards
What are the 4 tools that central banks can use to carry out monetary policy
Changing the base rate of interest
Quantitative easing
The reserve requirement
The exchange rate
Why does changing the base rate of interest have an effect on monetary policy
It will cause banks to change theirs causing either an incentivizing or disincentivizing borrowing
Why may changing the base rate of interest not be effective at tackling inflation
Inflation caused by rising costs cannot be tackled by decreasing demand
How long does it take monetary policy to have an effect
18 - 24 months
What are the likely effects of increasing the base interest rate
More people are going to save money
Fewer people are going to borrow money
The pounds value will increase due to hot money flowing in from other countries
What is hot money
Investors from foreign countries putting money into UK banks due to the higher intrest rates
Describe quantitative easing
A process by which the central bank buys back debts from financial organizations
What are the outcomes of QE
Increases money supply
Increases inflation
Raises interest rates
What is the main risk of using QE
Liquidity trap – Where financial organizations hoard cash instead of spending it
Describe the 2 types of monetary policy
Expansionary - putting money into the economy
Contractionary - removing money from the economy
What effect does changing the reserve requirement have on money supply
Increasing the reserve requirement means the MS decreases
Decreasing the reserve requirement means the MS increases
Describe why increasing the reserve requirement causes a decrease in MS
It means that there is a limit on how much money the banks can loan out
Liquidity trap
A situation when interest rates cannot fall any further resulting in monetary policy cannot influence AD
