Macro 3.2 Monetary policy Flashcards
What is monetary policy?
Monetary policy is the process by which a central bank manages the money supply and interest rates to achieve macroeconomic objectives.
It includes controlling inflation, consumption, growth, and liquidity.
What are the main tools of monetary policy?
- Interest rates
- Money supply
- Exchange rates
- Controls over bank lending
These tools help the central bank influence economic activity.
What is the purpose of interest rate changes in monetary policy?
To influence the cost of borrowing and the level of economic activity.
Lower interest rates generally stimulate spending, while higher rates can cool down an overheating economy.
What is quantitative easing?
A monetary policy where a central bank purchases financial assets (government bonds) to increase the money supply and lower interest rates.
It was used to stimulate the economy during the financial crisis of 2008 and in the decade after.
How does the base rate influence commercial banks?
The base rate affects the interest rates on loans and savings offered by commercial banks.
A low base rate encourages commerical bank lending, while a high base rate discourages it.
What is the monetary transmission mechanism?
The process by which a central bank’s monetary policy decisions affect the economy through various channels.
It includes impacts on interest rates, asset prices, and overall economic expectations.
What happens to household consumption when the base rate rises?
Household consumption typically falls as borrowing becomes more expensive.
Higher interest rates lead to increased loan repayments and lower discretionary income.
What is contractionary monetary policy?
A policy where the central bank raises interest rates or reduces the money supply to decrease demand and inflation.
It aims to stabilise the economy by controlling inflation.
What is expansionary monetary policy?
A policy where the central bank lowers interest rates or increases the money supply to stimulate economic activity.
It is intended to boost aggregate demand.
What impact do higher interest rates have on asset prices?
Higher interest rates generally lead to lower asset prices.
This can be explained that there are higher returns on deposits left in the bank and borrowing is more expensive. Therefore investors do not buy financial assets and householders do not borrow to buy houses so demand in the housing market falls, leading to lower house prices, lower wealth and less consumption.
What is the relationship between interest rates and consumption?
Higher interest rates typically decrease consumption as borrowing costs rise.
Conversely, lower interest rates can encourage spending.
What is a liquidity trap?
A situation where interest rates are very low, and people prefer to hold onto cash rather than spend or invest.
This limits the effectiveness of monetary policy.
What does the term ‘inflation targeting’ refer to?
A monetary policy strategy where the central bank sets a specific inflation rate as its goal.
It aims to stabilise prices and guide economic expectations.
What are the four functions of money?
- Medium of exchange
- Store of value
- Unit of account
- Standard of deferred payment
These functions facilitate economic transactions and value measurement.
True or False: The Bank of England sets the base rate, which influences the interest rates on all loans and savings.
True
The base rate is a key tool in monetary policy implementation.
Fill in the blank: A significant increase in the money supply can lead to _______.
[inflation]
This is a potential risk associated with quantitative easing.
What impact does a rise in the base rate have on expectations?
It may lead to decreased expectations for economic growth.
Higher rates can signal a tightening of monetary policy.
What is crowding out in the context of fiscal policy?
When government borrowing leads to higher interest rates, making it more expensive for private investors to borrow.
This can reduce private sector investment.
