Monetary Policy Flashcards
What does monetary policy refer to?
The use of interest rates and the money supply to influence the level of economic activity. The governments use monetary policy to reach the target inflation level.
How are the central banks involved in monetary policy?
The money supplied is controlled by central banks and they also set the interest rate which is called the base rate. Changing the base rate sends a message to financial instructions.
What is the interest rate?
It’s the reward for saving and the cost for borrowing.
What’s the UK target rate for inflation?
2% +/- 1%
What is liquidity preference?
Demand to hold money in the form of cash. At low interest there is a low opportunity cost of holding cash and it’s demanded more.
What can governments use to manage the money supply?
The base rate
The reserve requirement (used more in places like China)
The purchase and sales of government bonds
What is the base rate?
Interest rate charged by the central bank to the commercial banks when money is loaned. The central banks is a last resort for commercial banks when they can’t meet the demands for funds from their customers.
What is the reserve requirement?
Central bank controls the amount commercial banks have to keep on deposit to meet consumers demand. A decrease reserve requirement means commercial banks can lend out more money, increasing money supply as eventually decreasing the interest rate.
What is the sales and purchase of government bonds?
Commercial banks purchase bonds, thus lend the government money. They are traded on the stock exchange, so price can change daily.
How does the sales and purchase of government bonds affects the money supply?
Governments purchase bonds from commercial banks to expand the money supply as they would have more money to lend out, thus increase the money supply and decrease the rate of interest.
Selling bonds will reduce their ability to lend and decrease the money supply and increase the interest rate.
What is deflationary monetary policy for?
Decreasing AD by reducing money supplied and increasing interest rates, thus reducing consumption and investment.
What is expansionary monetary policy?
Increase AD by increasing money supplied thus decreasing decreasing interest rates, increasing consumption and investment.
When is quantitive easing used?
When interest rates are so low they can’t be reduced anymore, or when consumers and businesses have become unresponsive to changes in the interest rate.
What impact does quantitive easing have on AD?
The Bank of England purchase assets with electric money from the private sector which means all these institutes have more cash which they reinvest, by purchasing properties and companies shares. This increases the price of these and the wealth effect. This SD increases.
