Monetary Policy

Question 1

What does monetary policy involve

Answer 1

Central bank and or government decision on IRs, ERs and money supply

Question 2

How does a change in IRs affect ERs

Answer 2

High IR attracts hot money, so more demand for £, so ER up, so our net exports value increases (SR)

Question 3

What is the lender of last resort

Answer 3

Bank of England is the lender of last resort, meaning that if commercial banks suffer a shortfall of cash they can always borrow more money from BofE

Question 4

What are the functions of the Bank of England

Answer 4

Control money supply
Lender of last resort
Sets interest rates

Question 5

What is liquidity

Answer 5

The ease at which assets can be converted into cash

Question 6

What is a symmetrical inflation target

Answer 6

A requirement placed on BofE to respond when inflation is too low as well as too high

Question 7

What is UK inflation target

Answer 7

2%+-1

Question 8

What are the objectives of BofE

Answer 8

Inflation target,
Strong, sustainable and balanced growth that is environmental sustainable

Question 9

What does BofE have to take into account when setting IRs

Answer 9

Time lag - changes to IR take time to have an impact on overall economic activity. Can be up to 2 years, and when combined with future uncertainty it makes it difficult to know what effect they’ll have

Question 10

What does impact of IRs depend on

Answer 10

Liquidity traps - when everyone hoards money instead of saving or spending. Occurs during recession or when IRs are zero. People just hold onto cash due to fear of spending.
Lower effective bound - when further changes to interest rates no longer provide stimulus to AD.
What action do commercial banks take - they don’t have to match central banks in IRs
Confidence

Question 11

How does QE work

Answer 11

1. Central bank creates money
2. Buys bonds from financial institutions
3. This reduces IRs by increasing money supply
4. leading to businesss and people to borrow more
5. They spend more on C and Investment , which creates jobs and increases AD
6. Boosts the economy

Question 12

Why do interest rates fall with QE

Answer 12

When the bank buys lots of bonds, they rise in value, and the coupon rate stays the same, so the yield is lower (IR = yield)

Question 13

Evaluate impacts of QE

Answer 13

Can be ineffective if people hoard the cash
Cash availability remains low
Can lead to crowding out, so less investment
Opportunity costs: is 875bn pounds of QE the best usage of money

Question 14

What is QT

Answer 14

When BofE sells its bonds, and has to accept lower price to sell lots, so yield increases and IR increases

Question 15

How can banks directly intervene with monetary policy

Answer 15

By funding for lending, for example to stimulate lending activity