Monetary Policy Flashcards
What is monetary policy?
This is changes to interest rates, the money supply, and the exchange rate by the central bank, in order to influence AD.
What does expansionary monetary policy do and why may this be used?
The main purpose is to increase AD
It is used to:
Increase demand pull inflation to reach the inflation target.
Increase growth.
Reduce unemployment.
What does contractionary monetary policy do and why may this be used?
The main purpose is to decrease AD
It is used to:
Reduce inflation to reach inflation target.
Prevent asset/credit bubbles. Risk in finance sector.
Reduce excess debt and promote saving.
Reduce current account deficit
What is expansionary monetary policy transmission mechanism?
This is when the BOE cuts the interest rates, which affects a wide range of other interest rates.
What does cutting interest rates lead to?
Lower credit card IR. Easier to borrowing so consumption increases.
Lower saving rates. Reduces incentive to save.
Lower mortgage rates. Less paid towards this so more disposable income.
Lower rates on business loans. This increases investment.
Weaker exchange rate. Savers may look for countries with the best interest rates to save. This is hot money outflows, where the supply of the currency increases, depreciating it. This increases net exports.
What happens with LRAS and expansionary monetary policy?
If interest rates fall, investment increases shifting LRAS to the right. This investment will mean: higher quantity, quality, of capital, higher productive efficiency.
