Monetary Policy

Question 1

Monetary Policy

Answer 1

A type of demand-side polcies by central banks in which ineterst rates, exchange rates and money supply is manipulated to affect AD. Main purpose is the maintain long term price stability by decreasing fluctuations in the bsuiness cycle.

Question 2

Use of central Bank

Answer 2

1. the governments bank
2. banks to commercial banks
3. regulators of commercial banks
4. conduct monetary policy

Question 3

Why you CANNOT use all three monetary tools at once RWE

Answer 3

• send smixed signals to markets and reduces policy effectiveness

japan 1990 - CONCEPT INTERDEPENDENCE
- interest rates near zero = government increased money supply by buying bonds & assets
- NO INTEREST MANIPULATIOn = near zero, so wouldn’t stimulate demans
- NO EXCHANGE RATE MANIPULATION = Would conflict with Quantitative Easing inflation goals

=> Interest rates remained nea ´r zero until 2024 => central banks fix 1 problem at a time

Question 4

open Market operations - Quantitative easing

Answer 4

Expansionary: Government buys its own bonds back from consumers to increase money supply in the economy and therefore increase investment and consumption

Contractionary: Government sells its bonds and pays interest to those who buy them to tie up their money as savings in bonds = decrease moeny supply = decrease C & I = decrease AD

Question 5

Monetary policy - Interests

Expansionary Monetary policy

Answer 5

If inflation is below target objective
1- Decrease interest rates
2. decreased rewrad for saving = less incentive to save = take money out bankl to spend instead
3. decreased cost of borrowing = more likely to take loans = more capital investment

Question 6

Monetary policy - Interests

Contractionary Monetary Policy

Answer 6

If inflation is too high above target
1. Increase interest rates
2. higher cost for borrowing = less loans = lesss spending
3. higher reward for saving = increase incentve to save and earn interest on money & accumulate welath = decreased spending

Question 7

How interest rates are determined

Answer 7

Money Supply Diagram with perfectly inelasic supply of money & elastic demand for money (Interest rate vs quantity of money)

1) Supply of money is FIXED and doe snot depend on interest rates
2) if supply of money falls = scarcity of money supply
3) Cost of borrowing will go up = demand for money will go down
4) Interest rates will rise

Question 8

Limitations of monetary policies

Answer 8

1. Ineffective with already low interest rates
   => banks need to use unconventional methods (e.g open market operations- quantitative easing or negative interest rate)

2) Lower interest is inefficient in recession
=> people wont spend more anyway due to low confidence

3) Success is limited by accuracy of predictions for future
=> limited by time lag, incremental adjustments, shocks like civil war

4) credibility of central bank based on political dependence
=> central bank is supposed to be idnependent of government
=> only efficient if independent & public trusts their operations = can affect public spending behaviour properly & manage expectations

5) ineffective for cost-push inflation /SRAS)
=> does not tackle root cuase = PL will always increase
=> trade off & opportunity cost inflation vs Growth => WILL NOT tackle macro objectives

6) cannot be specifically targeted
=> blunt instrument & doe snot promote particular industries
=> income inequality sinc elower income individuals are unlikely to take loans as they cannot pay back

Question 9

Advantages of monetary policy over fiscal policy

Answer 9

• only interest manipulation = no budget deficit or dept
• no crowding out causing offset of govenrment spending by investment de reasing (the point of fiscal policy in the first place)
• flexible
• incremental & reversible

Question 10

Who/what does monetary poliy affect

Answer 10

LOW INTERESTS
* household dept and credit payables = lower monthly payment
* disposable income
* exchange range (lower interest=higher money supply= lower worth of currency=depreciation)
* affordable loans for hosues
* more government budget as less inetrests are paid on gov bonds

Question 11

Contractionary monetary policy diagram

Answer 11

Eliminates inflationary gap/ POG

Question 12

expansionary monetary policy diagram

Answer 12

aims to eliminate recessionary gap by shifting Ad out /eliminates NOG

Question 13

3 ways monetary policy targets money supply

Answer 13

Reserve requirement ratio adjustment
=> percentage of commercial bank deposits taht it CAnNOT lend out
=> ↑RRR = less loans lent out= ↓Money supply

Discount rate adjustment
=> rate at which commercial banks borrow from central banks

Open market operations through quantitatve easing