Macroeconomic policy chapter 9

Question 1

what is monetary policy?

Answer 1

The use of monetary instruments to try to achieve policy objectives. This includes interest rates, manipulation of the money supply and the exchange rate

Question 2

who implements monetary policy?

Answer 2

The central banks
- specifically the monetary policy committee who are nine economists who meet once and decide whether elements of the monetary policy needed altering

Question 3

what is the main monetary policy objective?

Answer 3

controlling inflation

Question 4

how can monetary policy be used to reduce unemployment?

Answer 4

reducing interest rates to try to reduce cyclical unemployment. Reduced interest rates encourage consumers to spend and businesses to borrow to invest.

Question 5

Disadvantages of the monetary policy in reducing unemployment?

Answer 5

• during recessions, business and consumer confidence tends to be low meaning they may not use these lowered interest rates to fund spending. This is called the liquidity trap
• recent economic history has shown that the Monetary policy is not very effective at lifting economies out of a recession and reducing cyclical unemployment

Question 6

how do changes in interest rates influence aggregate demand?

Answer 6

Via the transmission mechanism:
- when interest rates rise, demand for loans from businesses and consumers fall and aggregate demand should fall
- when interest rates fall, demand for loans from businesses and consumers should increase meaning AD should rise

Question 7

what is the impact of increases in interest rates on consumption?

Answer 7

• higher interest rates encourage more saving
• discretionary income (money you have after paying taxes and living expenses) decreases as mortgage repayments increase
• demand for new homes is likely to fall
• the value of shares are likely to decrease meaning consumers may feel less wealthy -> the wealth effect
• consumers may cut back on spending due to less confidence in future earnings

Question 8

effect of increases in interest rates on exports

Answer 8

• likely to lead to a rise in the exchange rate (cheap imports and expensive exports)
• this reduces aggregate demand

Question 9

effect of decreases in interest rates on exports and imports

Answer 9

• likely to reduce demand for imports and increase demand for exports due to a fall in the exchange rate
• this should increase aggregate demand