Monetary Policy

Question 1

Monetary Policy Definition

Answer 1

The use of Interest Rates to control the level of aggregate demand in the economy

Question 2

Bank Rate

Answer 2

The price of borrowing money from the central bank of country for commercial banks

Question 3

Market Rate

Answer 3

The price of households and firms borrowing money from commercial banks

Question 4

Transmission Effect

Answer 4

The overall impact across the economy from changes in the bank rate in terms of demand

Question 5

Impact on consumer spending of raising the Bank Rate?

Answer 5

• Decrease
• This is because households will gain more income from simply leaving their money in commercial bank accounts
• This means that overall demand across the economy has shrunk

Question 6

Impact on business investment of raising the Bank Rate?

Answer 6

• Decrease
• This is because it becomes more expensive for firms to borrow money from commercial banks
• This means it is harder for them to grow, therefore they are less attractive investment
• Overall demand across the economy shrinks

Question 7

Impact on exchange rates and current accounts balance of raising the Bank Rate?

Answer 7

• Exchange rates go up
• Because bank accounts in countries with higher interest rates are more desirable to investors
• Therefore demand for the currency will increase
• This will hurt the Net Trade Balance, because Strong Pound means that Exports become Dearer

Question 8

Effect on Aggregate Demand

Answer 8

All of this can be tracked on the Transmission Diagram. The overall effect of raising the Bank Rate is lowering aggregate demand

This lowers demand-pull inflationary pressure