Monetary Policy Flashcards
What does monetary policy involve
Changes in interest rates, the supply of money & credit and XRs to influence the economy
What does monetary policy influence
Decisions we make about how much we save, borrow and spend
What are the functions of money
- 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
What are the important aspects of monetary policy
- interest rates
- lending
- currency markets
- inflation targets
- bank of England
- European central bank
What is an interest rate
The reward for saving and the cost of borrowing expressed as a % of the money saved or borrowed
What are the different interest rates within a market
- on borrowing
- on mortgages
- on credit cards
- on government and corporate bonds
What is the real interest rates
The money rate of interest minus the rate of inflation
When do real interest rates become negative
When the nominal rate of interest is less than inflation
UK monetary policy - a brief history
1980s- belief in monetary policy
1990s- UK entered the EU XR + then move to floating XR
1997-2015- monetary policy committee set up
Bank of England
Founded 1694
They provide monetary and financial stability for the U.K.
Independent of the government
Since when have UK policy interest rates remained the same
Since March 2009
Key roles for a central bank
- monetary stability
- financial stability
What is monetary stability (roles of a central bank)
Stable prices and confidence in the currency
What is financial stability (roles of a central bank)
There is an deficit flow of savings and loans and confidence in financial intermediaries such as banks
Factors considered by the Bank of England when setting interest rates
- 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
GDP growth and spare capacity (factors considered by the Bank of England)
The main task is to set monetary policy so that AD grows in line with the country’s productive potential
What are lending indicators (factors considered by the Bank of England)
Confidence surveys can provide ‘advance warning’ of turning points in the economic cycle
Trends in global foreign exchange markets (factors considered by the Bank of England)
A weaker XR could be seen as a threat to inflation because it raises the prices of imported goods and services
Why do they have to look up to two years ahead when setting interest rates
Because when interest rates are changed, it takes time for them to have an effect on AD and prices
What does ‘forward guidance’ aim to do
Build confidence by signalling that official interest rates would stay at low levels for some time
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
Between 12-24 months
What is the transmission mechanism of monetary policy
1- change in market interest rates
2- impact on demand
3- effect on output, jobs and investment
4- real GDP and price inflation
What does the transmission mechanism of monetary policy reflect
The ways in which changes in interest rates influence AD, output and prices
What happens when the Bank’s own base interest rate goes up
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)
