Macro Pack 9 Flashcards
Define the term ‘monetary policy’:
Monetary policy refers to the use of interest rates and other monetary tools by the central bank (e.g. Bank of England) to influence aggregate demand, inflation, and economic growth.
Which are the two demand side policies?
Monetary policy
Fiscal policy
Explain how the base rate alters the rates of high street banks:
When the Bank of England changes the base rate, it influences the cost of borrowing and the return on savings for commercial banks, which then adjust their interest rates accordingly.
Define the term ‘interest rates’:
Interest rates are the cost of borrowing money or the return on savings, expressed as a percentage of the amount borrowed or saved.
Define the term expansionary monetary policy:
Expansionary monetary policy involves lowering interest rates or increasing the money supply to stimulate economic activity and increase aggregate demand.
Explain in detail how lower interest rates would affect consumer spending:
Lower interest rates reduce the cost of borrowing and the return on savings, encouraging consumers to borrow and spend more, thereby increasing consumption.
Explain in detail how lower interest rates would affect investment:
Lower interest rates reduce the cost of borrowing for firms, making investment in capital projects more attractive, which can increase investment.
Explain in detail how lower interest rates would affect net exports:
Lower interest rates tend to weaken the exchange rate, making exports cheaper and imports more expensive, which can improve the net export balance.
Which objectives would expansionary monetary policy hope to achieve?
Increase economic growth
Reduce unemployment
Avoid deflation or stimulate inflation toward the target (2%)
Why are the effects of changing interest rates subject to time lags?
It takes time for changes in interest rates to filter through the economy and affect consumption, investment, and inflation.
What is the liquidity trap?
A situation where interest rates are very low, and monetary policy becomes ineffective because people prefer to hold cash rather than borrow or invest.
What else may limit the impact of interest rate changes?
Consumer confidence
Level of indebtedness
Global economic conditions
Bank lending willingness
Explain how increasing the money supply can affect AD:
Increasing the money supply lowers interest rates and encourages spending and investment, shifting the aggregate demand (AD) curve to the right.
Explain how QE helps high street banks lend more money:
QE increases the reserves of commercial banks by purchasing financial assets, which increases liquidity and encourages lending.
How does QE lower interest rates? Use a diagram
QE increases demand for bonds, raising their prices and lowering yields, which pushes down long-term interest rates. (Diagram: bond market with price vs. yield)
How does QE lower exchange rates? Use a diagram
QE increases the money supply, which can depreciate the currency due to higher supply, boosting exports. (Diagram: supply and demand for currency)
What are the limitations of QE?
Can cause asset bubbles
May increase inequality
Limited impact if banks don’t lend
Risk of inflation if overused
What is the target for the monetary policy committee?
The inflation target is 2% (CPI), set by the government.
Give examples of at least four pieces of data the monetary policy committee looks at when making decisions:
Inflation rate (CPI)
Unemployment rate
GDP growth
Consumer/business confidence
Exchange rates
