Monetary Policy

Question 1

Define monetary policy

Answer 1

Bank of England controlling the interest rate to control inflation

Question 2

What is the UK inflation target and why is it set at this level?

Answer 2

2%- this is completely arbitrary.

There is no real reason other than for transparency as it establishes the trust in the central bank by consumers and businesses.

Question 3

How is the inflation target achieved?

Answer 3

The interest rate is adjusted every first Thursday of the month. The level of adjustment is decided by the monetary policy committee which consists of 4 members of the government and 5 members of the central bank. It is set by a vote.

Question 4

Why is there an odd number of members in the monetary policy committee?

Answer 4

In order to prevent a draw of votes

Question 5

Define symmetric inflation targeting:

Answer 5

When the central bank has the responsibility to act when inflation falls above or below their target.

e.g: Bank of England have to ensure the inflation rate is 2%

Question 6

Define asymmetric inflation targeting:

Answer 6

When a central bank only has the responsibility to ensure inflation does not increase above the inflation target.

(EU bank uses this)

Question 7

What is the current UK interest rate?

Answer 7

0.25%

Question 8

What is the current US interest rate?

Answer 8

0.5%

Question 9

What is the current Eurozone interest rate?

Answer 9

-0.1%

Question 10

What is the current Japanese interest rate?

Answer 10

-01%

Question 11

What is the base rate?

Answer 11

The interest that central banks lend at to commercial banks and the government.

Question 12

What is the commercial rate?

Answer 12

The interest rate at which consumers and investors can borrow money from profit making commercial bank organisations.

Question 13

What potential problems arise from very low interest rates?

Answer 13

If the IR is very low you cannot stimulate investment or consumption. Expansionary monetary policy is jammed. There will be a low profit level for banks so they’ll be reluctant to lend as there are less returns on lending. There is also lower returns on financial products- especially bonds so stock and bond markets suffer.

Question 14

Define narrow money (M0):

Answer 14

Notes, coins and commercial bank deposits in the Bank of England (liquid money).

Question 15

Define broad money (M4):

Answer 15

M0+ Wholesale and retail deposits with monetary financial institutions such as current accounts at banks and building societies.

Question 16

How can BofE increase the supply of broad money?

Answer 16

Through quantitative easing: The purchase of bad debt (think subprime mortgage crisis in 2008)

Question 17

What is a liquidity crisis?

Answer 17

A situation in which there is very little money but a lot of bad debt which disincentivised banks from lending.