Monetary Policy Flashcards
What is inflation?
Inflation is a general increase the price of goods and services in an economy.
Effects of high inflation rate?
Higher cost for essentials e.g food, rent, fuel
Reduced purchasing power: the same amount of money buys less than it used todo people need to cut back
Increased borrowing costs: if inflation causes interest rates to rise, loans and mortgages become more expensive which puts extra pressure on household budgets
Reduced savings
How do we calculate inflation?
Simple price index: we want to measure the price of a good over time, so we look at the two prices and compare them
Consumer price index: measures the change in the average level of prices paid for economic goods and services. It measures inflation, and therefore indicated the performance of the economy. It is used by workers when requesting pay rises, and it’s also used to make international comparisons.
Formula for simple price index
(Price in any year divided by the price in the base year) x 100
What is the consumer price index?
It measures the overall change in the price of goods and services that people typically buy over time. It does this by collecting approximately 53,000 prices every month and comparing these to the corresponding prices from the previous month
How is the CPI calculated?
Select representative base year
Decide what goods are going to be put in CPI based on the household budget survey
Gather data: obtain price of goods for time period being studied
Observe how much the typical consumer spend on the good as a proportion of total income
Multiply the price change index for each component of the index by its weight
Add up all price changes to get the overall change in prices
What are the economic uses of the CPI?
It measures the rate of inflation
It allows us to make international comparisons
It is used in wage negotiations
What is deflation?
Deflation is the sustained decrease in the general price of goods and services leg The Great Depression
Effects of deflation
Consumer spending falls: if there is steadily declining prices, consumers may decide to wait for prices to drop further and defer their spending. This causes the flow of money in the economy to slow down
Investment falls: if suppliers are potentially required to reduce prices, investment is less appealing
Employment falls: firms are making less money as they have to keep reducing prices to encourage consumers to buy, meaning they have to cut costs and therefore cut wages.
Government budget difficulties: due to an increase in unemployment during deflation periods, governments have to spend more on social welfare payments
Causes of inflation? (Three types)
Demand full inflation: when demand exceeds supply e.g the housing markets
Cost push inflation: when production costs rise and are passed on to consumers e.g oil and gas prices
Built in inflation: when expectations of future price increases lead to wage and price hikes e.g if transportation costs rise, workers may demand an increase in their wages
Causes of deflation
Decreased consumer demand: when demand falls, businesses may lower prices to encourage people to spend
A decrease in the money supply: tighter monetary policies might influence consumers to save their money instead of spend it
Technological advancements: means producers can lower their costs , which likely results in falling prices of goods
What is monetary policy?
The way in which a central bank affects the amount of money in circulation
Functions of the European Central Bank?
Currency issuance: issuing and managing the euro currency to ensure its integrity and availability
Bank supervision: supervising and regulating banks and financial institutions within the eurozone to maintain financial stability
Foreign exchange operations: managing the eurozone’s foreign exchange reserves and conducting foreign exchange operations
What is the European Central Bank?
Established June 1st 1998, located in Frankfurt, Germany
It is the bank of 19 European Union countries that have adopted the euro
They borrow money from other EU countries in case they are in debt e.g they loaned to Ireland during the recession in 2008
It controls the eurozone
How does the ECB implement monetary policy within eurozone countries?
Monitors the growth of money supply
Sets interest rates
Ensures minimum reserve requirements
What is price stability?
Price stability refers to a situation where the general level of prices in an economy remains relatively constant over time. This means that the prices of goods and services, on average, do not experience significant or persistent increases (inflation) or decreases (deflation).
How does the ECB impact Ireland?
The ECB sets monetary policy for the euro area, which includes Ireland. Since there is a single interest rate for the euro area, there can be different impacts on the euro area economies.
If there is a banking crisis, the ECB can provide emergency liquidity assistance. I.e cheap emergency loans to banks that are running out of funds.
What is the central bank of Ireland?
It is a part of the European System of Central Banks and is the main regulator for the majority of financial services provided in Ireland . It maintains price stability by trying to reduce inflation pressure in Ireland, it issues notes and coins and has the sole authority to print and mint euro notes and coins, it maintains financial stability by ensuring the financial markets are free from shocks and it supervises financial service providers
What are the benefits of the euro?
Elimination of exchange rate risk: eliminates exchange rate risks for countries within the eurozone. This is particularly beneficial for businesses involved in international trade and consumers who frequently travel across eurozone countries.
Increased trade: elimination of exchange rate uncertainty and currency conversion boosts trade between eurozone countries, promoting economic integration and cooperation
Reduced transaction costs: in eurozone, businesses and consumers cash benefit from reduced transaction costs because they don’t have to exchange currencies when conducting cross border transactions. This can facilitate trade and investment among member countries
