Monetary Policy

Question 0

4 costs of inflation?

Answer 0

Loss of international competitiveness
Redistribution of income (fixed income earners suffer)
Increased uncertainty
Investment from abroad might decrease (why buy a currency that is falling in value?)

Question 1

Define monetary policy?

Answer 1

Monetary Policy is changing the base rate of interest to influence the rate of growth of aggregate demand, the money supply and ultimately price inflation.

Question 2

4 benefits of inflation?

Answer 2

• inflation reduces the real interest rate (easy to pay off debts etc)
• increased prices allow firms to make more profits
• inflation provides a cushion against deflation
• wages can be decreased by increasing them at a lower rate than inflation so workers don’t feel like they’re getting a wage cut

Question 3

If inflation gets too high, what will the MPC do and how will it reduce spending and inflation?

Answer 3

Interest rates are raised so the cost of borrowing rises. This means:
-people who borrow lots to buy things are less likely to do so, so less spending
-homeowners with non-fixed IR on their mortgages will have to spend less to repay their higher IR.
Both of these shift the AD curve left with multiplier affects, and this MAY decrease price level (inflation) and real output.

Question 4

4 points on effectiveness of MP?

Answer 4

• shorter time lag than FP, altho still takes a while.
• doesn’t affect people with fixed rate mortgages as much
• rising interest rates hit whole economy and so normally worsen income distribution.
• can raise costs of production - but if inflation is cost pull inflation then the higher IR can just make the problem worse.