Monetary Policy Flashcards
Who is responsible for monetary policy in the UK?
The Bank of England’s monetary policy committee has responsibility for monetary policy in the UK
What does monetary policy involve?
Monetary policy involves altering base interest rates, which determine all other interest rates in the economy, or altering the quantity of money in the economy
What is the inflation target?
2%
What is the bank rate?
A bank rate is the interest rate at which a nation’s central bank lends money to domestic banks. The is often in the form of very short-term loans
What are market rates?
The interest rates charged by banks and financial institutions for loans and offered for savings accounts, influenced by the bank rate
What is the exchange rate?
The value of one currency in relation to another, influenced by monetary policy and interest rates
What is the monetary policy transmission mechanism?
The monetary policy transmission mechanism is the process by which changes in interest rates affect the economy
What are the names for the interest rate set by the central bank?
Official Rate
Repo Rate
Base Rate
Discount Rate
Bank Rate
What is the relationship between the market rate and the base rate?
The market rates such as mortgage and credit card rates all adjust in line with changes to the base rate
How do interest rates affect aggregate demand through consumption?
If the official rate of interest decreases, market rates decrease too
This makes loans cheaper, encouraging consumer borrowing and consumption
This causes AD and inflation to increase
How do interest rates affect aggregate demand through asset prices?
Fall in the interest rates makes mortgages cheaper, increasing demand for housing resulting in an increase in asset prices
This makes homeowners feel wealthier, increasing consumption, AD, and inflation
How do interest rates affect aggregate demand through confidence/expectation?
Changes in official interest rates affect expectations. If economic agents expect the economy to benefit, investments increase and consumers are more confident, increasing AD
How do interest rates affect aggregate demand through depreciating exchange rates?
Decreasing base rates cause currency depreciation as foreigners invest elsewhere
Depreciation makes exports more competitive increasing AD through trade balance
How do interest rates affect aggregate demand through appreciating exchange rates?
Increasing base rates increases foreign investment in UK assets
Excess demand causes appreciation reducing net exports and decreasing AD
What 4 factors can the base rate impact?
Market Rates
Asset Prices
Expectations/Confidence
Exchange Rate
What does monetary policy ultimately impact?
Aggregate Demand results in Inflation
What is a liquidity trap?
A situation in an economy where an increase in the money supply has no effect on the interest rates, AD, or economic growth
Economic agents prefer saving money rather than investing
What are time lags?
The time it takes for monetary policy actions to have their full effect on the economy
This ranges from 18 to 24 months
What is expansionary monetary policy?
Expansionary monetary policy aims to increase AD and economic growth
Cutting interest rates, Increasing money supply to boost economic activity
What is contractionary monetary policy?
Contractionary monetary policy aims to reduce the demand for money and limit the pace of economic expansion
Cutting interest rates
When does the liquidity trap occur?
When interest rates fall so low that most people prefer to let cash sit rather than put money in debt instruments
What impact does the liquidity trap have?
Monetary policymakers are powerless to stimulate growth by increasing the money supply or lowering the interest rate any further
What is a diagrammatic way of representing the liquidity trap?
X axis is demand for money
Y axis is interest rates
Increasing money supply has no effect on interest rates as the line is now flat whereas it was curved before
What are the limitations of monetary policy?
Difficult to control many objectives with one tool
Interest rates affect the exchange rates
Interest rates have unequal economic impacts
Time Lags
Liquidity Trap
