Monetary Policy
A policy that aims to control the total supply of money in the economy to try to achieve the government’s economic objectives
How Monetary Policy affects growth and employment?
If the Bank of England wants to achieve more employment and more economic growth, it will reduce the interest rate.
- Borrowing by consumers rises - lower interest rate means cost of borrowing is cheaper, encourage consumers to take out loans and spend.
- Borrowing by firms rises - borrowing is cheaper, encourage to take out loans and finance greater investments
- Saving falls - Low incentive to save, consumers rather spend
- Asset prices rise - More attractive to buy assets, causing a rise in prices and therefore a rise in wealth. Increase wealth also encourages consumer spending as confidence will be higher.
- Disposable income rises with household with mortgages - Monthly Mortgage repayments will fall(however not for fixed interest mortgage), as interest rates fall. More disposable income, more spending
- External value of the currency falls - reduced interest rate means less attractive to save money in pounds, less demand for the pound so value falls. Depreciation in the exchange rate makes UK exports more cheaper so more competitive. However imports are more expensive and this helps increase total demand in the economy.
How Monetary Policy affects Price Stability?
(Inflation target is 2%. If Bank of English anticipate inflation, MPC will increase interest rates. High interest rates, less spending, reduce total demand.)
- Borrowing by consumers fall - cost of borrowing is higher
- Borrowing by firms falls - cost of borrowing is higher
- Saving rises - reward for saving increases
- Asset prices fall - less attractive to buy assets, fall in prices, owners of assets wealth fall. Reduced wealth, less consumer confidence
- Disposable income for households with mortgages - Monthly mortgage cost rise, less disposable income, so spend less
- External value of the currency rises - increase in external value of currency, imports become cheaper, reduce inflation
Evaluate the effects of monetary policy on consumer spending
Use of interest rates
- Expect consumer spending to rise as interest falls. However, if interest rates fall by a little, not everyone would reduce their savings.
- Large proportion of households have mortgages. Fall in interest rates means they are likely to be paying less each month in mortgage interest payments. More disposable income to spend more.
- Higher interest rates cause consumers to save. However if there is a little increase in interest rate, we don’t know how many people would deliberately increase their savings and consume less.
- Some consumers are retired people, if interest rates rises, they have higher disposable income. If a country has a high proportion of saves, then lower interest rates with reduce the income of many people.
Evaluate the effects of monetary policy on borrowing
- Lower interest rates, increase borrowing as price of loans fall
- High interest rates, cost of borrowing is expensive
- However, consumer confidence - not all people would want to borrow more. So if confidence is low and a cut in interest rate may not encourage more spending
- Lower interest rates may encourage more people to become home owners and apply for mortgages, however in times of high interest households may be unable to afford the cost of borrowing and demand for mortgages fall.
Evaluate the effects of monetary policy on saving
- Rise in interest rate means that saving is more attractive, however not all consumers may save due to them having a credit card
- Some savers are retired and rely on their saving
How Monetary Policy achieves economic objectives?
Economic Growth
Reduced interest rates - increase spending, output, employment
How Monetary Policy achieves economic objectives?
Low unemployment
Reduced interest rates - increase spending, output, employment
How Monetary Policy achieves economic objectives?
Price stability
Increased interest rate - reduced spending, so more Price Stability
How Monetary Policy achieves economic objectives?
A healthier balance of payments
Increased interest rate - reduced spending, including spending on imports
