Monetary Policy and Supply side Policy Flashcards
Define monetary policy?
Government decisions which control the supply of money
What are examples of monetary policy?
- The interest rate
- Credit control
- The exchange rate
Which area of monetary policy is actually controlled by the British government?
-The interest rate is controlled by the government
What may changes in the interest rate affect?
- Consumption
- Investment
- Exports and Imports
What would the effect of a fall in the interest rate be on households?
- A low interest rate causes consumers to spend more and save less
- A low interest rate reduces the opportunity cost of consumption
- Borrowing is cheaper and more accessible
- Mortgagee are cheaper
- demand for houses rises
- house prices rise
- increase the wealth effect
- demand for houses rises
- Variable rate mortgagee
- payments go down
- discretionary income rises
What would the effect of a fall in the interest rate be on firms?
- Cost of borrowing falls for capital goods
- Investment is more likely
- Investment becomes less risky
- Rate of interest should be equal to or lower than the rate of return
- more consumption from households will lead to more investment from firms to meet demand
What would the effect of a fall in the interest rate be on exports?
- Low interest rates
- international savers withdraw their money
- exchange rate falls
- export price decreases
- demand rises
- export price decreases
- exchange rate falls
- international savers withdraw their money
The extent of the effect of a fall in the interest rate on households, firms and exports?
- Households: -people may not even know what interest rate is
- Firms: -Other more significant factors
- More reluctant for larger firms because they have more people skilled in economics
- What if capital is produced from own funds? - Exports:- Will only affect country’s who have lots of people investing money from foreign countries like UK
What are advantages of changing interest rate for monetary policy?
- It’s flexible:
- interest rates can be changed monthly
- It’s visible:
- most involved in borrowing and saving know the rate
- It has a wide reach:
- affects many households and firms
How is the Interest rate transmitted from the bank of England to consumers?
- Bank of England sets base rate
- > All other financial institutions like commercial banks set a range of interest rates (they decide)
- > customers chose the best one
What is the link with base interest rate set by the Bank of England and the interest rates set by commercial banks?
- The interest rate given by banks is based on the base rate given by the bank of England but it is not the same
- If the base rate is high, most interest rates will be high
- If the base rate is low, most interest rates will be low
Define Supply side policy?
Any government action aimed at increasing the productive capacity of a country
How is supply side policy achieved?
- Increasing the quantity of factors of production
- Increasing the quality of factors of production
Examples of supply side policy?
-Investment subsidies
-reduce corporation tax
-subsidies for research and development to produce more efficient technologies
-ensuring appropriate quality of and wide access to education
-assistance and finance for business start-ups
-skills related training e.g. apprentice schemes.
-reducing power of trade unions
-cutting benefits to the unemployed
Privatising
Evaluating supply side policy?
- Cost vs Quality, just because it is done, doesn’t mean it is done well
- The time lag
- The state of the economy
- effects on AD
