2.6.2 Demand Side Policies Monetary Policy Flashcards
(13 cards)
What is monetary policy?
It’s changes to interest rates the money supply and the exchange rate by the central bank in order to influence AD
Why is contractionary monetary policy through rising interest rates good in slowing A.D.
It can increase the cost of borrowing for firms and consumers
If there is less borrowing and more saving demand for assets for and that will be a negative wealth affect
Helps to reduce inflation and stabilise prices
More sustainable, boring and lending can a car only those that need to borrow and can’t afford it can borrow
Reduces current account deficit as it reduces income leads to lower imports
What are the negatives of using contractionary monetary policy by using higher interest rates?
If interest rates are too high, it may cause a shock leading to lower growth and higher unemployment which could lead it to a recession
Impact on indebted as it’s hard to service debt and there could be bankruptcy for houses and firms
Reduces investment as borrowing costs are high and is bad for Lras growth
Worsening current account deficit via exchange rate strengthening as there could be hot money in flow
What does expansionary monetary policy aim to do?
And why is this policy used?
Aims to increase AD and demand pull inflation
Increase inflation
Increase growth
Reduce unemployment
Used to reach the inflation target
Explain the expansionary monetary policy transmission mechanism and what happens and how that promotes economic growth
An interest rate cut from the central bank will go through a transmission
Credit card interest rates will fall leading to less borrowing costs for consumers driving up consumption
Saving rates will decrease leading to increase incentive to spend
Mortgage rates will decrease which means more disposable income for consumers to spend
Rates on business loans will decrease causing businesses an incentive to borrow and fund the investments increasing LRAS
Weak exchange rate as there will be a hot money out for which increases supply of currency weakening it
What are the issues with expansionary monetary policy?
There is a trade of when the objective is to reach the inflation target and when growth and employment are priority
Demand pull inflation and current account deficit can occur
negative impact on savers as the rate of return with savings is less if there is less savings there’s less of a safety net for unintended consequences
A time lag for interest rate cut to really impact economy it takes around two years
What are some evaluative points on expansionary monetary policy?
Size of the output gap if negative output gap is small they won’t be much growth instead inflation overshoot
Both consumer and business confidence is have to be high then only low interest rates will give them incentive to spend and invest
Depends on the bank’s willingness to lend and if they will pass on the cut, they might not lend money making interest rate cut pointless
Size of the rate of the cut it needs to be enough of a cut to stimulate AD
What is quantitative easing?
Purpose of it?
It’s a type of monetary policy when the central bank buys financial assets in exchange for money to increase money supply
The purpose of it is to get money moving around the economy during times of very low demand
How does quantitative easing work?
The Bank of England generates new money electronically
This money is then used to buy financial assets government bonds from financial institutions
The bank sells these assets which provides banks with additional reserves
With more reserve banks are encouraged to increase lending to businesses and consumers
Increase lending needs to higher spending investment a and economic growth
What is the objectives of quantitative easing
Stimulate economic growth by encouraging borrowing and spending
Combat deflation as money supply increases downward spiral of prices prevent prevented
No long-term interest rates to encourage borrowing
Support financial markets by increasing liquidity
I said prices will rise due to bank buying them creating wealth effect
What are the drawbacks of quantitative easing?
Inflation risks as excessive increase in money supply can lead to higher inflation
I said bubbles can’t occur as low interest rates may inflate prices in assets like housing and stocks
Income inequality as asset price increases can benefit wealthy individuals
Central bank losses arising interest rates can lead to losses on assets purchased
What happens to the exchange rate when there’s a low interest rate?
Commercial banks cut the interest rates, including savings
Rates of return on savings decrease in UK
Investors might move some of their savings out of UK banks including hot money outflow
Pound depreciate as there is less amount for
What are the benefits of higher interest rates on Lras as evaluation?
Higher rates can cause appreciation of exchange rates
Which allows businesses to buy imported capital equipment for less and other stuff for lower prices
