Monetary Policy Flashcards
What is demand-side monetary policy?
use of interest rates, changes in the money supply and/or changes in the exchange rate to affect AD
*Ran by the independent Bank of England (BoE) in the UK.
What is the base bank rate?
the main interest set by the Bank of England; it is the rate at which commercial banks can borrow from the BoE.
What are market interest rates?
Rates of interest available to borrowers and savers
They vary depending on:
• risk
• amount borrowed/saved
• access to savings
*they typically follow the Bank base rate up/down.
What is the Central Bank?
the monetary authority and major regulatory bank in a
country.
A central bank is responsible for operating monetary policy and maintaining financial stability e.g. the UK’s BoE
How can interest rate changes feed through to AD and influence inflation?
• Higher interest rates raise the cost of borrowing, which slows consumer spending (C) and business investment (I).
• This reduces AD aggregate demand for goods and services, which in turn eases upward pressure on retail prices.
• Higher interest rates lead to an appreciation of the currency making imports cheaper which then helps to reduce inflation.
• Higher interest rates increase the return on savings, which encourages saving and
helps to reduce inflationary pressures from excess aggregate demand.
• Central banks might also think that an increase in the cost of borrowing sends a message to businesses and unions when negotiating pay settlements.
What is Quantitative Easing?
increases the supply of money in the banking system
*Expansionary monetary policy
What is expansionary monetary policy?
• cutting interest rates
• increasing the money supply via QE to stimulate AD growth to prevent deflation
*a depreciation on the currency can boost AD too
What is contractionary monetary policy?
• raising interest rates
decreasing the money supply via QT to slow AD growth and help control inflation
an appreciation on the currency can slow AD too
