Monetary Policy

Question 1

Define monetary Policy?

Answer 1

involves changes in interest rates, the supply of money and credit and exchange rates to influence the economy

Question 2

What is expansionary monetary policy?

Answer 2

• AD rises
• fall in nominal and real interest rates
• measures to expand supply of credit
• depreciation of exchange rate

Question 3

Breifly explain deflationary monetary policy?

Answer 3

• lower AD
• higher interest rates on lonas and savings
• tightening of credit supply
• appreciation of the exchange rate

Question 4

TRANSMISSION MECHANISM

Question 5

What is the transmission mechanism of moneatry policy?

Answer 5

ways in which changes in interest rates influence aggregate demand, output and prices

Question 6

GIve three logical chain of reasoning for rising of interest rates?

Answer 6

• more expensive to borrow –> lower incentive
• higher reward for saving –> greater incentive to save
• rates rise on variable rate mortgages –> less discretionary income

all lead to fall in consumer spending, falling AD and fall in inflationary pressure

Question 7

WHat is the MPC

Answer 7

monetary policy committee

- sets interest rates monthly

Question 8

WHat is the FPC?

Answer 8

financial policiy commitee

- safeguarding financial stability

Question 9

What are interest rates?

Answer 9

reward for saving and the cost for borrowing expressed as a percentage of the money saved or borrowed

Question 10

Name the six types of interest rates in modern economy ?

Answer 10

• bank loans
• mortgages
• credit card rates
• payday loans
• corporate loans
• government bonds

Question 11

What does the bank of england set policy interest rates consistent with?

Answer 11

the need to meet an inflation target of consumer price inflation of 2%

Question 12

Give some examples of what interest rates are set on?

Answer 12

• GDP growth and spare capacity
• bank lending
• equity markets
• consumer and business confidence
• unemployment and employment data

Question 13

What is a reduction in interest rates an example of?

Answer 13

expansionary monetary policy

Question 14

What will lower interest rates do in economy?

Answer 14

• cost of servicing loans/ debt is lower (boosts spending power)
• higher consumer confidence
• discretionary income rises
• higher business investment
• housing market is effected
• cheaper currency increasing exports

Question 15

Impact of lower interest rates on demand side of economy?

Answer 15

• reduces savings ratio and makes borrowing more attractive so consumption rises
• increases real national output
• creates employment

Question 16

Impact of lower interest rates on supply side?

Answer 16

• can stimulate businesses investment into capital process to improve their productivity and efficiency
• investment componant of AD, so shifts outwards
• productive capacity increases, higher growth and employment

Question 17

What is the downside of lower interest rates/

Answer 17

• banks less willing to lend
• low consumer confidence
• huge levels of debt
• ## falling or slowing rise asset process

Question 18

Give a logical chain of reasoning for higher interest rates?

Answer 18

MPC raises interest rates –> signals tighter MP –> market interest rates increase –> cost of borrowing rises –> main effect will be through mortgages –> slowdown in housing market –> contraction in retail credit –> currency appreciation –> makes Uk exports more expensive in overseas market

Question 19

What will investers do if the exchange rate increases and what is the impact?

Answer 19

• move money to the Uk in order to get the best return –> HOT MONEY
• increse demand for UK pound increases the exchange rate
• exports less attractive, imports more
• worsens balance of payments on current account

Question 20

When does a liquidity trap occurs?

Answer 20

• low interest rates and high amount of cash balances in the economy fail to stimulate aggregate demand

Question 21

What are some reasons for a liquidity trap/

Answer 21

• risk adverse commercial banks
• low confidence in private sector businesses and consumers
• low interest elasticity of demand

Question 22

What are the three main ways that interest rates decrease demand?

Answer 22

• reduce household spending
• reduce business investment
• changes in interest rates affect exports and imports via exchange rate

Question 23

Evaluation points for monetary policy?

Answer 23

• time lags in the economy
• not an exact science, humans are unpredictable
• doesnt work in isolation