Monetary Policy

Question 1

Tight monetary

Answer 1

high interest rates and low credit availability, strong exchange rate done to reduce AD

Question 2

Loose monetary

Answer 2

low interest rates and high credit availability, weak exchange rate done to increase AD

Question 3

what is the main aim of monetary policy

Answer 3

low inflation

Question 4

who decides the interest rates

Answer 4

monetary policy committee

Question 5

what kind of target does the MPC have

Answer 5

symmetric target - inflation is permitted 1% either direction of the target

Question 6

How is the Bank of England independent and accountable

Answer 6

Independent - Interest rates can’t be set by the government
Accountable - If inflation rises or drops MPC must write to the chancellor

Question 7

What does the MPC consider before making interest rate decisions

Answer 7

House prices
size of output gaps
exchange rate
rate of change in average earnings

Question 8

liquidity trap

Question 9

what will tight monetary policy do to the components of AD

Answer 9

consumption - decrease
investment - decrease
BoP - Worsen
Gov Spending - increases

Question 10

Liquidity Trap

Answer 10

Loose fiscal policy is ineffective if there is low confidence in the economy

Question 11

what do high interest rates do to the exchange rate

Answer 11

increases demand for the pound , hot money inflows which cause the exchange rate to appreciate

Question 12

why is there a time lag between change in interest rate and the effects

Answer 12

firms plan very carefully with their investment plans , asset buying takes a long time

Question 13

what does a reduction in interest rates do to asset prices

Answer 13

reduces mortgage and saving rates so asset prices will rise as people are more confident so buy more

Question 14

when is quantitative easing used

Answer 14

To stimulate AD at a time when interest rates are already very low

Question 15

what is the main function of QE

Answer 15

to increase the money supply

Question 16

Evaluation of QE

Answer 16

• 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

Question 17

Explain the process of QE

Answer 17

• 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

Question 18

Benefits of QE

Answer 18

• Maintains a weak currency which improves exports
• Boosts overall confidence
• Increases AD

Question 19

What is the relationship between Bond Price and yield

Answer 19

Inverse

Question 20

explain the secondary process of QE relating to Bond yield

Answer 20

• 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

Question 21

explain the process of Quantitative tightening

Answer 21

• 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