Monetary Policy

Question 1

define MP

Answer 1

involves using interest rates and money supply to influence the levels of consumer spending and aggregate demand
= aims to stabilise the economic cycle =keep inflation low and avoid recessions

Question 2

Aim inflation rate

Answer 2

2%

Question 3

describe expansionary MP

Answer 3

aims to increase AD
decrease IRs

Question 4

adv of EMP

Answer 4

• low IR on credit cards= low borrowing costs
  = incentivise borrowing and decrease saving
  = increase MPC= higher spending
• lower mortgage rates= households pay less monthly
  = more disposable income= more spending
• incentive to borrow for firms= higher investment
  = new capital, labour etc= higher productive efficiency = higher LRAS

Question 5

describe contractionary MP

Answer 5

aims to decrease AD
high IRs

Question 6

adv of CMP

Answer 6

• less demand pull inflation due to low AD
• discourage household and corporate debt
  = high IR= high cost of borrowing= more saving
  = less systemic risk for bank= less risk of recession
• affordable housing due to high mortgages
  = less AD for houses= low price= more affordable for first time buyers to access market= high SOL= less wealth inequality= more social mobility
• less CA deficit= less disposable incomes= less AD of imports

Question 7

disadvantage of CMP

Answer 7

• less business investment due to high cost of borrowing
  = less productivity= less SR and LR growth
• less growth due to less spending= risk of recession
  = lead to cyclical unemployment= low incomes= low SOL
• worsen CA deficit via strengthened exchange rate
  = high IR= high hot money inflow= more savings from abroad into UK= high demand for the pound£
  = high value pf the £= imports become cheaper= worsen CA

Question 8

cons of EMP

Answer 8

• demand pull inflation= create excess inflation which exceeds target
• increase CA deficit due to high growth= high incomes
  = more AD of imports= widen CA deficit
• negative impacts on savers
  = low rate of return on savings= if inflation is greater than nominal IRs, real return on savings cld be negative= return is less than price of goods= de-incentivise to save= more risk on individuals= no safety net to fall back on
• time lags for IR cut to finally feed through channels of transmission mechanism to increase AD
  = takes around 18 months- 2 years to work in UK

Question 9

effectiveness depends on…

Answer 9

• size of output gap= close to unemployment
  = any low IR may not decrease unemployment dramatically
  = mainly effects inflation overshooting the target
• economic cycle position= if economy in recession= low IR has more potential to increase growth and lower unemployment
• high consumer confidence= more likely to increase borrowing and spending at low IR
  businesses must be confident in future state of economy and AD expectations= more reason to invest at low IR
• size of cut rate= high cut= expansionary more desirable

Question 10

define quantitative easing

Answer 10

• non-traditional monetary policy tool used by central banks to stimulate the economy when conventional monetary policy becomes ineffective
• involves the central bank purchasing long-term financial assets, such as government bonds or other securities, from commercial banks and financial institutions

Question 11

how does QE work?

Answer 11

• central bank buys financial assets, usually government bonds, from commercial banks
  = increases the demand for these assets, raising their prices and lowering their yields (interest rates)
• by buying these assets, the central bank injects money into the banking system
  = provides banks with more liquidity to lend to households and businesses
  = increased demand for bonds raises their prices and lowers their yields (interest rates)
  = makes borrowing cheaper for businesses and consumers, =encourages investment and spending

A weaker currency can help boost exports by making them cheaper for foreign buyers.

Asset Price Inflation: By buying bonds and other assets, QE can also push up the prices of other financial assets, such as stocks and real estate. This can create wealth effects, where households and businesses feel richer and are more likely to spend.

Question 12

disadv of QE

Answer 12

• if the supply of a currency increases but demand stays constant (or does not increase proportionally), traders and investors may expect that currency to be worth less
  = lead to a depreciation of the domestic currency in foreign exchange markets
  = imports become more expensive= increase prices of goods as most firms get proaction resources from abroad
  = could trigger cost inflation

Question 13

functions of central bank

Answer 13

• manages currency, supply of money and interest rates in an economy
• issue physical cash securely
• manages public debt