Monetary Policy Flashcards
what is monetary policy
Involves the use of monetary policy instruments such as interest rates, the exchange rate and the supply of money and credit to meet macroeconomic objectives.
Who is monetary policy controlled by
Monetary policy is controlled by the Bank of England who meet monthly to set the bank rate.
what is expansionary monetary policy
Monetary policy that increases AD through low interest rates, increasing the money supply and a weak exchange rate
what is contractionary monetary policy
Monetary policy that decreases AD through High interest rates, decreasing the money supply and a strong exchange rate
Effects of high interest rates
High interest rates increase the cost of borrowing as well as the reward (rate of return) from savings
- Increased saving and less spending = fall in AD
- Reduces disposable income
effects of low interest rates
Low interest rates decrease the cost of borrowing but also decrease the rate of return from savings
- Lower savings and increased spending =
increased AD
- increased disposable income
What is the relationship between interest rates and the exchange rate and why
Higher interest leads to increased exchange rate.
If UK interest rates are relatively higher to other countries: people, firms and financial institutions outside of the UK put money into UK banks for the high rate of return
This increases the demand for the pound which strengthens it, leading to an increased exchange rate
Explain the process of quantitative easing
Involves purchasing government bonds to increase the money supply
Purchasing government bonds means you are lending money to the government that will be paid back at an increased rate of interest
The Bank of England purchases government bonds to then provide commercial banks with additional income
This increases the money supply and now firms and consumers can borrow from banks which leads to increased investment and spending, and eventually increased AD
What are supply side policies?
Supply side policies aim to improve UK economic performance in the long run by increasing the productive capacity and efficiency
