Monetary Policy Flashcards
What is the monetary policy goal
keep cpi at 2% +/- 1%
What does monetary policy aim to influence
level of demand in the economy
How does the monetary policy influence level of demand
controlling the base interest rate
Who controls the base interest rates
bank of england
When interest rates are low what happens
it is cheaper to borrow so people save less and spend more
What does low interest rates result in
demand pull inflation
When interest rates are high what happens
Reward for saving is better and cost of borrowing is higher
People spend less because it is more profitable to save money
What do high interest rates result in
less total demand since consumers have less money
Explain the lending rate channel for an increase in interest by BofE
base rate increases (BofE interest rate)
Therefore LIBOR rates increase
This means market rates increase
(borrowing decreases
saving increases
spending decreases)
THIS MEANS AD decreases and CPI back on track
Explain the exchange rate channel for an increase in interest by BofE
base rate increases (BofE interest rate)
Therfore LIBOR rates increase
Market rates increase
(increased reward for saving)
therefore foreigners find £ more attractive for their investments
HOT money flows into the UK
Demand for £ increases and £ gets stronger
(increases in value)
THEN demand for IMPORTS increase (we can get more bang for buck)
demand for EXPORTS decrease (foreigners dont want to pay more)
FINALLY AD will then fall
What part of the AD equation does the lending rate channel effect
consumer spending
investment
government spending
(C+I+G)
What part of the AD equation does the exchange rate channel effect
exports
imports
(x-m)
