Monetary Policy

Question 1

What is the money supply?

Answer 1

Total amount of money circulating in an economy.

M0= narrow money
M4= broad money

Question 2

Narrow money?

Broad money?

Answer 2

=notes, coins and balances available for normal financial transactions

=money held in banks and building societies that is not immediately accessible, notice is required to make withdrawals e.g savings

Question 3

Liquidity spectrum?

Answer 3

=the degree to which an asset can be quickly bought or sold

1. Money today= narrow money, most liquid (coins, notes) M0
2. Current accounts
3. Deposit accounts
4. Property= broad money, least liquid, M4

Question 4

What are 2 influences on demand for holding money?

Answer 4

Holding money= cash
•income= higher it is, more demand
•interest rates= higher it is, less demand as more held in banks

Question 5

Explanation of the interest rates/ price of holding money graph?

Answer 5

• demand for money downward sloping= higher interest, higher saving
• money supply inelastic= Bank of England control supply

Question 6

Nominal?

Real?

Answer 6

=doesn’t include inflation

=adjusted for inflation

Question 7

What is ‘hot money’?

Answer 7

=large companies will invest where interest rates are high as they earn a higher return

Question 8

Some factors the MPC consider when setting interest rates?

Answer 8

• supply of money (broad)
• demand (income)
• UK growth (GDP)
• equity markets
• unemployment
• oil prices
• consumer/business confidence

Question 9

What is the monetary base control method of controlling money supply?

Answer 9

=forcing banks to hold a certain proportion of assets on hold+direct control on bank lending

Quantitative= max limits on amount bank can lend/rate they can expand total deposits

Qualitative= persuade banks to lend to only certain types of customers

Question 10

What is the open market operations method of controlling the money supply?

Answer 10

=issuing Gov bonds which pass money to banks from non-financial sector (people)

Reduces money supply as money lodged in BoE not counted

Question 11

Expansionary?

Answer 11

• interest rates set 4% or less
• higher domestic demand
• ‘wealth effect’
• lower exchange rate (WPIDEC)

Question 12

Contractionary?

Answer 12

• interest rates set 5.5% or above
• lower domestic demand
• higher exchange rate (SPICED)

Question 13

Quantitative easing?

Pros and cons?

Answer 13

=pumping money into economy by buying assets e.g shares

Pros:
•higher AD as C+I+E higher

Cons:
•inflation
•banks may not lend
•no guarantee C+I increase

Question 14

Monetary policy?

Answer 14

• interest rates
• bank lending
• quantitative easing
• inflation target= 2%

Question 15

What are the 6 factors of the transmission mechanism of monetary policy?

Answer 15

Interest rates transmit their way to AD in following ways:

1. Household demand affected as effects savings, therefore spending
2. Households/firms with an existing debt (mortgage) affects repayments
3. Borrowing encouraged/discouraged
4. Consumer+business confidence (spending)
5. Asset values= lower interest rates, saving less attractive so property+household wealth^
6. Exchange rate

Question 16

What does the transmission mechanism of monetary policy argue?

Answer 16

Extent of effects of interest rates on inflation can only be seen after 2 years due to the amount of factors involved.