Monetary Policy

Question 1

What does monetary policy involve

Answer 1

Changes in interest rates, the supply of money & credit and XRs to influence the economy

Question 2

What does monetary policy influence

Answer 2

Decisions we make about how much we save, borrow and spend

Question 3

What are the functions of money

Answer 3

• medium of exchange
• unit of account used to relative measure prices and draw up accounts
• standard of deferred payment e.g. pay layers
• a store of value

Question 4

What are the important aspects of monetary policy

Answer 4

• interest rates
• lending
• currency markets
• inflation targets
• bank of England
• European central bank

Question 5

What is an interest rate

Answer 5

The reward for saving and the cost of borrowing expressed as a % of the money saved or borrowed

Question 6

What are the different interest rates within a market

Answer 6

• on borrowing
• on mortgages
• on credit cards
• on government and corporate bonds

Question 7

What is the real interest rates

Answer 7

The money rate of interest minus the rate of inflation

Question 8

When do real interest rates become negative

Answer 8

When the nominal rate of interest is less than inflation

Question 9

UK monetary policy - a brief history

Answer 9

1980s- belief in monetary policy
1990s- UK entered the EU XR + then move to floating XR
1997-2015- monetary policy committee set up

Question 10

Bank of England

Answer 10

Founded 1694
They provide monetary and financial stability for the U.K.
Independent of the government

Question 11

Since when have UK policy interest rates remained the same

Answer 11

Since March 2009

Question 12

Key roles for a central bank

Answer 12

• monetary stability

- financial stability

Question 13

What is monetary stability (roles of a central bank)

Answer 13

Stable prices and confidence in the currency

Question 14

What is financial stability (roles of a central bank)

Answer 14

There is an deficit flow of savings and loans and confidence in financial intermediaries such as banks

Question 15

Factors considered by the Bank of England when setting interest rates

Answer 15

• GDP growth and capacity
• bank lending and consumer credit figures
• equity markets (share prices)
• consumer and business confidence
• growth of wages
• trends in exchange markets
• international data

Question 16

GDP growth and spare capacity (factors considered by the Bank of England)

Answer 16

The main task is to set monetary policy so that AD grows in line with the country’s productive potential

Question 17

What are lending indicators (factors considered by the Bank of England)

Answer 17

Confidence surveys can provide ‘advance warning’ of turning points in the economic cycle

Question 18

Trends in global foreign exchange markets (factors considered by the Bank of England)

Answer 18

A weaker XR could be seen as a threat to inflation because it raises the prices of imported goods and services

Question 19

Why do they have to look up to two years ahead when setting interest rates

Answer 19

Because when interest rates are changed, it takes time for them to have an effect on AD and prices

Question 20

What does ‘forward guidance’ aim to do

Answer 20

Build confidence by signalling that official interest rates would stay at low levels for some time

Question 21

How long can it take for the full effects on real GDP and the inflation rate after a policy change in interest rates to be seen

Answer 21

Between 12-24 months

Question 22

What is the transmission mechanism of monetary policy

Answer 22

1- change in market interest rates
2- impact on demand
3- effect on output, jobs and investment
4- real GDP and price inflation

Question 23

What does the transmission mechanism of monetary policy reflect

Answer 23

The ways in which changes in interest rates influence AD, output and prices

Question 24

What happens when the Bank’s own base interest rate goes up

Answer 24

Commercial banks and building societies will typically increase how much they charge on loans and the interest that they offer on savings (depresses AD- save than spend)