Monetary Policy

Question 1

Examples of Expansionary Monetary Policy

Answer 1

• Fall in nominal and real level of interest rates
• measures to expand / increase the supply of credit
• Depreciation of the external value of the exchange rate

Question 2

Examples of Deflationary Monetary Policy

Answer 2

• Higher interest rates on both loans and savings
• Tightening of credit supply
• Appreciation of the exchange rate

Question 3

Low interest rates impact on Governments macro objectives

Answer 3

• Low interest rates = excess aggregate demand - > demand pull inflation
• interest rates are low = liquidity trap
• nominal interest rates are less than one per cent, return on saving is likely -> real spending decreases
• Low interest rates = mal investment
• sustained rise in house prices because of low mortgage cost
• Low interest rates = higher consumer demand for imports

Question 4

Role of Central Bank

Answer 4

• Setting interest rates (+ QE)
• Financial regulation
• Lender of last resort
• Debt management (e.g. government bonds)

Question 5

Role of BOE

Answer 5

• Free-floating currency
• 2% inflation target
• QE (UK = £445bn)
• Capital/liquidity requirements for banks

Question 6

QE

Answer 6

Introduction of new money into the national money supply

Question 7

QE how works

Answer 7

• Wealth affect - lower interest rates lead to higher share and bond price
• Borrowing cost effect - QE lowers the interest rate on long term debt
• Lending effect - increases liquidity of banks = more lending
• currency affect - exchange rate depreciation = higher exports

Question 8

Currency appreciation does what

Answer 8

• exports more expensive & likely lead to inward shift of AD
• Imports cheaper & outward shift of AS

Question 9

Currency depreciation does what

Answer 9

• Inflation - fall in a currency = rise in import prices + cost-push inflationary pressure + domestic energy and food bills
• Export demand + trade balance - weaker currency makes exports cheaper - rising export sales + stronger trade balance -> increase AD
• Rise in exports + falls in imports increase AD - Export profits = stimulus to the labour market + weaker imports have fall in interest rates

Question 10

Macroeconomic objectives

Answer 10

• Low and stable rates of inflation (e.g. 2% target of CPI)
• Sustained growth of real GDP
• Low unemployment / rising employment
• Higher average living standards
• Balanced trade on the current account of the BOP
• Achieve a more equitable distribution of wealth + income