19)demand Management (2): Monetary Policy

Question 0

What does interest rates mean

Answer 0

⚫️cost of borrowing

⚫️reward of savings

Question 1

What does monetary policy mean

Answer 1

⚫️use of interest rate and money supply
➡️to manipulate the level of AD in the economy

⚫️controlled by the bank of England

Question 2

What other roles do the bank of England have

Answer 2

⚫UKs central bank

⚫️decides on the amount of money in circulation
➡️and issues bank notes

⚫️banker of the Government

⚫️ banker to the banking system
➡️will act as lender of last resort when bankrupt

⚫️manages the countries gold and foreign currency reserves

⚫️regulates the UKs banking and financial system

Question 3

What does base rate mean

Answer 3

the minimum rate of borrowing in the economy

Question 4

How long does it take for interest rate to fully feed through into the economy

Answer 4

12-24 months

Question 5

What piece of info does the MPC need to consider to help it to predict inflation in 12-24 months

Answer 5

⚫️unemployment statistics

⚫️sales of UK exports

⚫️government spending plans

⚫️wage rate rises

⚫️consumer and business confidence surveys

⚫️cost of raw materials

⚫️asset prices

Question 6

Why is unemployment statistics help it to predict inflation in 12-24 months

Answer 6

⚫️if unemployment is low
➡️this could lead to cost-push pressures
➡️as firms have to offer higher wages to attract workers

Question 7

Why is sales of UK exports help it to predict inflation in 12-24 months

Answer 7

⚫️An increase in demand for UK exports
➡️will increase AD
➡️putting pressure on price level

Question 8

Why is government spending plan help it to predict inflation in 12-24 months

Answer 8

⚫️an increase in government spending
➡️increase AD
➡️increase the price level

Question 9

Why is a rise in wage rate help it to predict inflation in 12-24 months

Answer 9

⚫️a large increase in national minimum wage
➡️lead to increase cost of production
➡️shifting AS to the left
➡️causing cost-push inflation

Question 10

Why will consumer and business confidence survey help it to predict inflation in 12-24 months

Answer 10

⚫️if consumers or firms worried about the future
➡️they may cut down on their spending plans
➡️leading to a reduction in C and I
➡️a fall in AD
➡️a reduction in price level

Question 11

Why is the cost of raw materials help it to predict inflation in 12-24 months

Answer 11

⚫️a rise in oil of gas prices
➡️lead to cost-push inflation
➡️due to increase costs of production for firms

Question 12

Why is the asset prices help it to predict inflation in 12-24 months

Answer 12

⚫️a decrease in house prices
➡️mean people who own such asset will feel poorer
➡️wealth effect
➡️may cut back spending plans
➡leading to fall in C
➡️decrease in AD
➡️reduce price level

Question 13

What are all interest rate decisions based on

Answer 13

Forecasts of the future

Question 14

What will happen if data suggests that forecast inflation will rise above the 2% target

Answer 14

⚫️MPC will consider tightening monetary policy

➡️by increasing interest rates

Question 15

What will happen if data suggests that forecast inflation will fall below the 2% target

Answer 15

⚫️MPC will consider loosening monetary policy

➡️by reducing interest rates

Question 16

What does tight MPC mean

Answer 16

An increase in interest rate

Question 17

What will happen if theres an increase in interest rate

Answer 17

⚫️leads to leakage of 
➡️consumption
➡investment
➡️net export
⚫️AD will shift to the left

⚫️if they forecast that inflation rising above target
➡️the MPC will use this to slow growth of the economy

Question 18

What is a loose monetary policy

Answer 18

Reduction in the interest rate

Question 19

What will happen if interest rate decreases

Answer 19

⚫️lead to injection of extra
➡️investment
➡️consumption
➡️net export
⚫️AD will shift to the right

⚫️if MPC forecast that inflation is falling below target
➡theyll use this to boost the economy

Question 20

What does the interest rate have an impact on

Answer 20

⚫️exchange rate

⚫️firms

⚫️savers

⚫️borrowers

Question 21

How does the interest rate increasing have an impact on the borrowers

Answer 21

⚫️mortgage interest payments rise

⚫️households with mortgages have less money to spend

⚫️wealth effect
➡️demand for houses falls
➡️house prices fall
➡️home owners feel less worthy
➡️consumption falls
➡️AD shifts to the left
➡️price level and inflation falls

Question 22

How does the interest rate increasing have an impact on the savers

Answer 22

➡️saving becomes more attractive

➡️more income is saved

➡️less is spend

➡️consumption decreases

➡️AD shifts to left

➡️price and inflation decreases

Question 23

How does the interest rate increasing have an impact on the exchange rate

Answer 23

➡️uk becomes more attractive place to save

➡️hot money flows into the UK

➡️demand for £ increases

➡️value of the £ increases

➡️UK exports become more expensive

➡️net export decreases

➡️AD shifts to the left

➡️price level and inflation decreases

Question 24

What is the impact of tight monetary policy on AD and inflation

Answer 24

➡️AD decreases ➡️inflation decreases

Question 25

What is the impact of loose monetary policy on AD and inflation

Answer 25

➡️AD will increase ➡️inflation will increase

Question 26

Why is monetary policy effective

Answer 26

⚫️interest rate can respond quickly to the problems in the economy ⚫️changes in the interest rate have large impacts on consumption and investment ⚫️long run impact on investment and AS ⚫️An independant bank will be tough on inflation

Question 27

How is interest rate responding quickly to problems in the economy effective for monetary policy

Answer 27

⚫️MPC of bank of England meets monthly ➡️can raise/lower interest rate immediately as it wishes ❎fiscal policy on the other hand, is changed once a year on budget day

Question 28

How is changes in interest rate having a large impact on consumption and investment effective for monetary policy

Answer 28

⚫️has large impact on AD and economy ⚫️changes in any demand management policies like fiscal policy and monetary policy ➡️have big impact on AD and economy ➡️because of multiplier effect ➡️describe multiplier with example n formula

Question 29

How is long run impact on investment and AS effective for monetary policy

Answer 29

⚫️if interest rate decreases ➡️AD will increase in short run ➡️as investment increases ➡️this could also shift AS in the long run ➡️as capital stock is updated ➡️becomes more productive ➡️increasing quality of nations factor of production and its ability to produce goods

Question 30

What are the limitations of monetary policy

Answer 30

➡️time lags ➡️magnitude ➡️fixed rate mortgages and loans

Question 31

Why is time lags a limitation of monetary policy

Answer 31

``` ⚫️changes in the interest rate takes a long time to feed through ➡️consumption ➡️investment ➡️AD ➡️economy transmission mechanism ➡️takes between 12-24 months ``` ⚫️thus bank of England ➡️emphasises regular small changes in interest rate

Question 32

Why is the magnitude a limitation of the monetary police

Answer 32

⚫️impact on economy depends on magnitude on interest rate ➡️MPC usually raises/lowers rates by only 0.25% ➡️unlikely to have major impact on economy ➡️on its own in the short run

Question 33

Why is fixed rate mortgages and loans a limitation of monetary policy

Answer 33

⚫️interest rate changes may not have much effect on ➡️households that have fixed rate mortgages and loans ⚫️fixed rate mortgages ➡️becoming increasingly popular in Uk over last decade ⚫️household on variable rate mortgages and loans ➡️will be immediately affected when interest rate changes