Monetary Policy Flashcards
Tight monetary
high interest rates and low credit availability, strong exchange rate done to reduce AD
Loose monetary
low interest rates and high credit availability, weak exchange rate done to increase AD
what is the main aim of monetary policy
low inflation
who decides the interest rates
monetary policy committee
what kind of target does the MPC have
symmetric target - inflation is permitted 1% either direction of the target
How is the Bank of England independent and accountable
Independent - Interest rates can’t be set by the government
Accountable - If inflation rises or drops MPC must write to the chancellor
What does the MPC consider before making interest rate decisions
House prices
size of output gaps
exchange rate
rate of change in average earnings
liquidity trap
what will tight monetary policy do to the components of AD
consumption - decrease
investment - decrease
BoP - Worsen
Gov Spending - increases
Liquidity Trap
Loose fiscal policy is ineffective if there is low confidence in the economy
what do high interest rates do to the exchange rate
increases demand for the pound , hot money inflows which cause the exchange rate to appreciate
why is there a time lag between change in interest rate and the effects
firms plan very carefully with their investment plans , asset buying takes a long time
what does a reduction in interest rates do to asset prices
reduces mortgage and saving rates so asset prices will rise as people are more confident so buy more
when is quantitative easing used
To stimulate AD at a time when interest rates are already very low
what is the main function of QE
to increase the money supply
Evaluation of QE
- Banks and people may not spend money but invest or save it so QE is ineffective
- Increases House prices imbalancing economy
- QE was so specific to 2008 crisis it isn’t relevant
- May increase private sector debt, already 9 million
Explain the process of QE
- BofE credits the account and buys gov bonds from financial institutes
- Banks have more cash to lend so then consumers have more cash so spending and investment increase which increases AD
Benefits of QE
- Maintains a weak currency which improves exports
- Boosts overall confidence
- Increases AD
What is the relationship between Bond Price and yield
Inverse
explain the secondary process of QE relating to Bond yield
- BofE buys bonds which increases demand and so price for them
- This decreases bond yield so decreases interest rates on mortgages and savings
- This causes people spend more so AD increases
explain the process of Quantitative tightening
- Gov sells bonds to Banks which reduces money supply of banks which reduces bank lending
- Central bank isn’t purchasing Bonds so demand and price drops, this causes yields to rise and then interest rates causing spending to reduce
