Monetary Policy Flashcards
What’s quantitative easing?
Where the central bank, with government approval, electronically prints money and pumps it into the economy through the financial markets. It buys corporate and government bonds which reduces the yield rate because there’s an inverse relationship between price and yield rate. This will encourage commercial banks to lend to the real economy.
Why would a bank use quantitative easing?
Because of the fear of deflation, particularly malign deflation. It’s used after positive interest rates have fallen into the liquidity trap and after negative interest rates have failed.
What’s an example of quantitative easing?
During the 2008 financial crash, the Bank of England bought £460 billion of QE. The federal reserve undertook $3 trillion of QE during this time.
What are the problems with quantitative easing?
Can be inflationary - Fisher’s quantity theory of money, where MV = PT.
Banks are risk averse - especially during a recession or deflation - government overcame this by project Merlin.
It may not boost consumption if households save during deflation.
It can weaken the exchange rate; the Marshall learner and j curve mean that the trade deficit gets worse.
Firms who profit maximise make less profits, meaning they have to cut costs.
It can reduce business and consumer confidence.
What’s monetary policy?
The use of interest rates and the money supply to maintain price stability.
What are negative interest rates?
They only apply to commercial bank deposits at the Bank of England. Commercial banks will lend to the real economy instead of to the Bank of England.
What’s the liquidity trap?
It 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.
How much QE did banks undertake during the credit crunch?
Bank of England - £460 million
European Central Bank - £1 billion
Federal reserve - £2 billion
What’s Fisher’s Quantity Theory of Money?
States that the general price level of goods and services is directly proportional to the money supply. As the velocity of circulation and the volume of transactions are constant, an increase in the money supply will lead to an increase in price level.
What’s expansionary monetary policy?
Monetary policy that aims to raise the price level and increase AD.
What’s contractionary monetary policy?
Monetary policy that aims to lower the price level and reduce AD.
What are the benefits of expansionary monetary policy?
Increased money supply
Increased growth
Increased employment
What are the drawbacks of expansionary monetary policy?
Demand pull inflation
Negative impact on savers
Time lags
Less competitive exports
What are the evaluations of expansionary monetary policy?
Depends on the size of the output gap
Depends on consumer/Business confidence
What are the benefits of contractionary monetary policy?
Decreased inflation
Discourages household/corporate debt
Encourages saving
Reduces the current account deficit
