Theme 2: Monetary Policy Flashcards
What are the two tools to impact monetary policy?
Changing interest rates and changing the money supply
What is monetary policy?
Monetary policy is when the central bank manipulates the base interest rate or the money supply in order to influence aggregate demand.
What 4 areas does changes in the base interest rate effect?
- Savings
- Mortgages
- Investment
- Net Exports
What is expansionary monetary policy?
Decrease interest rates which shifts AD out as people will borrow more so consumption and aggregate demand will increase.
What is contractionary monetary policy?
If the inflation rate is above the target, the Bank of England will pursue contractionary monetary policy. This involves increasing the base interest rate in order to decrease aggregate demand and reduce inflation.
Who runs the bank of england?
9 economists of the Monetary Policy Committee. Lead by Andrew Bailey.
What happens to consumers MPS and MPC when base interest rates decrease?
Marginal propensity to save decreases and marginal propensity to consume increases.
How might decreasing interest rates not encourage economic growth?
Pensioners will have a lower return on their savings and so have less disposable income and so will spend less reducing consumption.
When did the Monetary Policy Committee use expansionary fiscal policy? And Why?
During the 2009 financial crash in order to stimulate growth by discouraging saving and increasing the marginal propensity to consume.
What is contractionary monetary policy?
Increasing interest rates to reduce spending
How does quantitative easing work?
The bank of England electronically creates new money and this new money is used to buy financial assets such as government bonds from high street banks. So high street banks have more money to lend out making them more likely to loan increasing consumption.
What is the effect of quantitative easing on exchange rates?
Increase in the supply of pounds will cause the exchange rate to depreciate. This will make exports cheaper and imports more expensive. Leading to an increase in net exports and so aggregate demand will shift out.
What is the effect of lowering interest rates on getting a mortgage?
Cheaper mortgages mean more people will be willing and bale to take out a mortgage which allows them to buy a house which will shift the demand curve to the right and increase house prices.
Leading to postive wealth effect
Why is positive wealth effect non existent in many European countries? and according to who?
Sousa- Lots of people do not own their own homes so feel as though they need to save even more to be able to afford a house.
What percentage of people don’t own their own house?
76%
What will be the impact of a reduction in the base interest rate on investment?
A reduction in the base interest rate will increase investment. Investment is a component of aggregate demand and so this will shift out. Investment will also increase productivity which will cause the long run aggregate supply curve to shift out and increase real GDP.
When might a decrease in the base interest rate not impact investment?
However, if aggregate demand and animal spirits are particularly low, firms might be concerned that investment will be wasted. This could mean that they do not make a profit on the investment, leaving them unable to pay it back and therefore in debt. So, a decrease in the interest rate might not actually increase investment and economic growth.
When does LRAS change?
When there has been a change in the quantity or productivity of the factors of production.
Why might an increase in interest rates cause inflation?
Cause cost push inflation as it will increase the cost of loan repayment for firms. This will shift SRAS in and force firms to increase their prices. Which goes against the aims of contractionary monetary policy.
What happens if the pound gets stronger?
SPICEE
Stronger Pound: Imports Cheaper, Exports Expensive.
What happens to the balance of trade if the exchange rate appreciates?
An appreciation of the exchange rate will cause import expenditure to increase and export revenue to decrease. This will worsen the balance of trade.
What happens to AD if the pound appreciates?
- Increase in import expenditure as cheaper
- Decrease in export revenue as less competitive
- X-M so AD decrease.
What is the positive consequence of higher interest rates causing a stronger pound?
Imports are cheaper so firms costs decrease so firms can reduce prices.
