Monetary policy

Question 1

What is monetary policy

Answer 1

Monetary policy refers to the use of interest rates and other monetary tools by a central bank (in the UK, this is the Bank of England) to influence economic activity, control inflation, and achieve economic objectives.

Question 2

What are the key objectives of monetary policy

Answer 2

Control inflation
economic growth
reduce unemployment
maintain balance of payments stability

Question 3

What happens if interest rates increase or decrease and who are they made by

Answer 3

l Controlled by the central bank.
• A higher interest rate makes borrowing more expensive and saving more attractive, which slows down spending and reduces inflation.
• A lower interest rate makes borrowing cheaper and encourages spending and investment, stimulating economic growth.

Question 4

What is quantitative easing and the effect

Answer 4

• The central bank creates new money electronically and uses it to buy financial assets, like government bonds.
• Increases the money supply, lowers interest rates, and stimulates borrowing and investment.

Question 5

What are the two types of mortgages

Answer 5

Fixed and variable

A fixed-rate mortgage is a loan where the interest rate remains the same for a set period, usually 2, 5, or 10 years.

A variable-rate mortgage is a loan where the interest rate can change over time, usually in line with changes to the Bank of England’s base rate.

Question 6

What are the costs on monetary policy

Answer 6

Time Lag:
• Monetary policy takes time to have an impact

Impact on Borrowers and Savers:
• Higher interest rates increase the cost of borrowing, leading to higher mortgage and loan payments, which can reduce disposable income for households.
• Conversely, lower interest rates can harm savers as they earn less on their savings.

Ineffectiveness in Severe Recessions:
• During periods of low confidence, even very low interest rates might not encourage spending or investment, reducing the effectiveness of monetary policy.

Income Inequality:
• Quantitative easing (QE) can disproportionately benefit asset holders (e.g., those owning stocks and property), widening the wealth gap.

Risk of Inflation:
• Expansionary monetary policy, if overused, can lead to excessive inflation, eroding the purchasing power of consumers.

Question 7

What are the benefits of monetary policy

Answer 7

Control of Inflation:
• Monetary policy helps maintain price stability by adjusting interest rates.
• For example, increasing interest rates reduces spending and lowers inflationary pressure.
2. Stimulates Economic Growth:
• Lower interest rates encourage borrowing and investment, boosting economic activity during a slowdown.
3. Reduces Unemployment:
• Expansionary monetary policy (lower interest rates or quantitative easing) creates jobs by encouraging businesses to invest and expand.
4. Flexibility:
• Monetary policy can be adjusted relatively quickly to respond to economic changes, such as recessions or inflation spikes.
5. Encourages Savings (when rates are high):
• Higher interest rates make saving more attractive, benefiting savers and improving financial security.

Question 8

What does the effectiveness of monetary policy depend on

Answer 8

The state of the economy , for example it is more useful when consumers and businesses are confident