4.2.4 Financial markets and Monetary policy Flashcards
(25 cards)
What is a central bank?
Government’s bank that issues currency and controls the supply of money in the economy
Who is responsible for setting monetary policy in the UK?
Monetary policy committee
What is the current inflation rate target?
2% CPI
What does the central bank discuss when they meet 8 times a year?
Set the bank rate and discuss if quantitative easing is required
What does expansionary monetary policy include?
Reducing interest rates, increasing QE, or depreciating the exchange rate
What is the aim of expansionary monetary policy?
Shift aggregate demand (AD) to the right
Diagram for expansionary monetary policy
What would be the effect on the economy of USA Federal Reserve Bank committing to extra $60bn a month of QE?
Commercial banks receive cash for their bonds → liquidity in the market increases → commercial banks lower lending rates → consumers and firms borrow more → consumption and investment increase → AD increases
What does contractionary monetary policy include?
Increasing interest rates, decreasing/stopping QE, or appreciating the exchange rate
Diagram of contractionary monetary policy?
How can the central bank increasing interest rates impact the consumers?
Existing loan repayments for households become more expensive → disposable income reduces → consumption decreases → total demand falls
How can central bank increasing interest rates impact firms?
Firms are less likely to borrow → less investment in capital takes place → AD falls
How can central bank increasing interest rates impact exchange rate?
Hot money flows increase → the exchange rate appreciates → exports more expensive and imports cheaper → net exports reduce → AD decreases
What is the main goal of MPC?
Price stability
What are the two main instruments of monetary policy?
Adjustments to interest rate
Quantitative easing
What is quantitative easing?
When the central bank purchases bonds on the open market in order to increase money supply
What is the official rate?
Base rate of interest set by MPC
What are market rates?
Interest rates set by commercial banks for their customers
What is net external demand?
Demand for a country’s exports
How does a decrease in interest rates impact the exchange rate?
Less attractive for investors who move money out of the UK > demand for pound falls > currency depreciates
How does an increase in interest rates impact the exchange rate?
More attractive to investors who move money into the UK > demand for pound increases > appreciation in exchange rate
Give an example of a monetary policy contractionary demand-side policy?
Increase interest rates
Diagram of demand-side contractionary policy?
Give an example of a monetary policy expansionary demand-side policy?
Reduce interest rates
