Monetary policy

Question 1

What does the MPC consider?

Answer 1

Exchange rates, oil prices, economic growth, the level of consumer spending, global interest rates, stock markets, unemployment rate, availability of credit and the size of the output gap.

Question 2

What is monetary policy?

Answer 2

The use of interest rates and money supply to influence AD and achieve price stability.

Question 3

Who sets the interest rates in the UK?

Answer 3

The Monetary Policy Committee.

Question 4

How often do the MPC meet to discuss monetary policy?

Answer 4

They meet monthly.

Question 5

When is an expansionary monetary policy used?

Answer 5

When inflation is below 2%

Question 6

What are synonyms for expansionary?

Answer 6

Loose and reflationary.

Question 7

What is the effect of an expansionary monetary policy?

Answer 7

It shifts AD right.

Question 8

What does an expansionary monetary policy consist of?

Answer 8

Reduced interest rates and an increase in the money supply.

Question 9

How does a reduction in interest rates lead to an increase in AD?

Answer 9

There is a lower reward for saving so less people save which means there is an increase in consumption, there is a lower cost of borrowing so there is a larger incentive to borrow meaning there is more consumption, investment projects appear more attractive which leads to increased investment, there is a fall in hot money inflows therefore there is a lower demand for the sterling so there is a weaker exchange rate and they lower the cost of mortgage repayments so people have more money to spend via consumption.

Question 10

What does a contractionary monetary policy consist of?

Answer 10

Increased interest rates and a reduction in the money supply?

Question 11

What is the effect of a contractionary monetary policy?

Answer 11

It leads to the AD curve shifting inwards.

Question 12

What are synonyms of contractionary?

Answer 12

Tight and deflationary.

Question 13

What are synonyms of contractionary?

Answer 13

Tight and deflationary.

Question 14

What is hot money?

Answer 14

Capital which is frequently transferred between financial institutions in an attempt to maximise interest or capital gain.

Question 15

How is the independence of the MPC an evaluation point of monetary policy?

Answer 15

Before the MPC took charge over monetary policy, the Bank of England simply advised the government on what to do but the government still had the final say, this independence has meant that there has been more confidence in markets as firms and individuals know that the MPC will now always intervene to retain excessive inflation. As a result, we have seen a period of high investment and lower wage demands as firms and individuals expect a stable economic environment.

Question 16

How is the regularity of the change of monetary policy an evaluation point for monetary policy?

Answer 16

The MPC meet each month therefore interest rates can be adjusted each month - this makes it more effective than fiscal policy as whenever policy needs changing it can be changed immediately. This should instil confidence into the markets.

Question 17

How are time lags an evaluation point for monetary policy?

Answer 17

The MPC estimate that it can take one year for the effects of the policy to affect the behaviour of individuals and firms and then a further year to impact inflation. This time lag exists as firms need time to plan and execute an investment project, many mortgages are fixed rate and consumers take time to recognise money may be best off in a savings account. This makes monetary policy less effective as expectations for the future economy are frequently inaccurate and so the policy set now may not be the best for the longer term economy.

Question 18

How are time lags an evaluation point for monetary policy?

Answer 18

The MPC estimate that it can take one year for the effects of the policy to affect the behaviour of individuals and firms and then a further year to impact inflation. This time lag exists as firms need time to plan and execute an investment project, many mortgages are fixed rate and consumers take time to recognise money may be best off in a savings account. This makes monetary policy less effective as expectations for the future economy are frequently inaccurate and so the policy set now may not be the best for the longer term economy.

Question 19

How is the elasticity of the AS curve an evaluation point for monetary policy?

Answer 19

If the economy is in a slump and there is lots of spare capacity then any cut in interest rates will have a relatively large effect on GDP but less of an effect on inflation. It is thus important that the MPC has reliable data and can make accurate predictions of the future economy based on this.

Question 20

How are wider macroeconomic effects of monetary policy an evaluation point for monetary policy?

Answer 20

They only have one target which is inflation therefore there may be trade-offs with several other economic policies and a high IR may not be suited for all sectors.

Question 21

How is the effectiveness of monetary policy during a credit crunch an evaluation point for monetary policy?

Answer 21

Banks are unwilling to lend out money due to the fear of it not being repaid, this has undermined the effectiveness of the MP as when the bank lowers interest rates this should lead to more borrowing however the issue is the availability of credit as banks don’t want to lend money even when interest rates are low.

Question 22

What has the problem of the availability of credit led to?

Answer 22

Rather than relying solely on IR, the MPC has turned to injecting new money into the economy through the purchase of bonds and other assets. By doing so they are effectively lending money directly to governments and first bypassing the banks in the process.

Question 23

Why might a tight monetary policy be inflationary?

Answer 23

AS shifts to the left as it is more expensive to borrow money therefore there is less investment into research and development. This reduces the productive capacity of the economy.

Question 24

Why might a cut in interest rates harm the distribution of income?

Answer 24

Pensioners are a ‘poor’ group in society and they are often savers so they are adversely affected and businesses may borrow more to expand their business.

Question 25

Why might a cut in interest rates help with the distribution of income?

Answer 25

It reduces the cost of borrowing which is good for borrowers and borrowers are often the poor whilst it reduces the returns from saving which is bad for savers and savers are usually the rich.