8. Monetary Policy Flashcards
What is a Monetary Policy?
Monetary policy involves controlling the supply of money in the economy, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency.
What are Interest Rates? (Related to MP)
Interest rates refers to the base rate, the rate at which the Central Bank are prepared to lend to other banks. Lower interest rates in theory, increase the demand for money.
What is the Money supply?
Money Supply is the total amount of money in circulation or in existence in a country. It includes actual notes and coins and also any deposits which can be quickly converted into cash.
What is Quantitative Easing?
The Central Bank creates new money electronically to buy financial assets, like government bonds from the financial institutions. Replacing their financial assets with cash provides the financial institutions with money which they use to increase lending in the economy, helping growth.
(Buy Bonds to gain money to Lend)
How can ‘Altering Exchange rates’ act as a monetary policy?
Changes in exchanges rates initially work there way into an economy via their effect on prices. For example, deliberately devaluing a currency makes exports cheaper creating extra demand for domestic companies.
What is inflation rate targeting?
In the UK the main objective of the Bank of England is to deliver price stability – low inflation.
Price stability is defined by the Government’s inflation target of 2%.
What does inflation rate targeting affect?
Inflation rate targeting affects all the economic agents, households, businesses and governments.
It increases the level of certainty in the economy which helps to boost consumer and business confidence. It makes it easier to control expectations.
Is Monetary Policy effective? (Yes points)
Monetary policy has less of a time lag than fiscal and is ideal for fine tuning the economy.
It is also much more direct at tackling inflation which is the source of many economic problems.
Also the Bank of England and Federal reserve are independent of government and therefore focused on economic, not political outcomes.
Is Monetary Policy effective? (No points)
As its much less direct that fiscal policy it also may be less likely to work out the ways its intended.
Monetary policy is ineffective in times or global recession.
Also, there is the problem of the liquidity trap.
What is a liquidity trap?
A liquidity trap is a situation in which monetary policy
becomes ineffective. This occurs when cuts in interest rates seem to have little or no impact on aggregate demand.
How to overcome a liquidity trap effect?
In a liquidity trap, fiscal policy may become more important as an instrument of demand-management e.g. running a larger budget deficit to boost demand and increase the money supply.
There is also pressure on central banks to supply the financial markets with extra liquidity to encourage them to lend to each other again and increase the flow of funds available for borrowers. This is where QE came to be used as a kind of alternative monetary policy.
What is symmetric inflation?
A symmetrical inflation target is a requirement placed on a central bank to respond when inflation is too low as well as when inflation is too high.
E.g. UK
What is asymmetric inflation?
An asymmetrical inflation target non-symmetrical inflation target—it is compelled to take action only when inflation is too high.
E.g. ECB
