Monetary Policy Flashcards
(15 cards)
What is monetary policy?
Monetary Policy- Using interest rates to influence the level of aggregate demand in the economy.
What are interest rates?
Interest rate- Cost of borrowing and reward for saving.
There are different rates of interest in an economy…
Different banks charge different interest rates to compete with eachother.
Rates are higher if money is borrowed without security. For example, the rate charged on a mortgage to buy a house will be lower than rates on an unsecured loan.
The amount paid to borrowers> the amount given to savers. PROFIT
Higher interest for credit card users. Unsecured loan.
What are two types of Monetary policy?
Contractionary Monetary Policy- Aims to decrease aggregate demand through a rise in interest rates.
Expansionary Monetary Policy- Aims to increase aggregate demand through a decrease in interest rates.
What is contractionary monetary policy?
Contractionary Monetary Policy- Aims to decrease aggregate demand through a rise in interest rates.
What is expansionary monetary policy?
Expansionary Monetary Policy- Aims to increase aggregate demand through a decrease in interest rates.
What are the impact of interest rates on consumers?
Consumers
Reduced cost of borrowing- therefore more consumers take out loans to buy products eg cars, furniture and holidays.
Existing loans (eg mortgages) also fall so more disposable income to spend
Reward for saving lower- incentive to spend rather than save
What are the impact of interest rates on firms?
Firms
Reduced cost of borrowing, reduced costs on existing loans lead to increased profits.
Increased levels of business confidence and investment, since a large proportion of business investment is funded through borrowing, returns on investment will increase.
Exchange rates fall.
Exports become…
What is the effect of monetary policy on Economic Growth?
Lower cost of borrowing, lower reward for saving + lower debt repayments = higher consumer + investor spending
Higher Aggregate Demand
Higher Output in the Economy
Higher Economic Growth
What is the effect of monetary policy on Low Unemployment?
Low Unemployment
Lower cost of borrowing, lower reward for saving + lower debt repayments = higher consumer + investor spending
Higher AD
Higher Output
Higher derived demand for Labour
What is the effect of monetary policy on Price Stability (low inflation)?
Lower cost of borrowing, lower reward for saving + lower debt repayments = higher consumer + investor spending
Increase AD
AD > AS
Inflationary pressures force prices up
What is the effect of monetary policy on Balance of Payments?
Lower cost of borrowing, lower reward for saving + lower debt repayments = higher consumer + investor spending
More spending = increase in AD
Import more
Balance of Payments Current Account deteriorate
Though- lower interest rates leads to lower exchange rate and exports cheaper and imports more expensive and improve current balance.
Depends on…
Income elasticity of imports- If demand for imports income elastic, then lower interest rates will increase demand.
Strength of link between IR and ER- If link is strong then lower interest rates will lower ER.
PED of imports and exports- If both price elastic and lower interest rates lead to lower exchange rates, imports dearer and exports cheaper.
What is money supply?
Money supply- amount of money circulating in the economy.
What is quantitative easing?
OPPOSITE IS QUANTITATIVE TEASING?
Buying of financial assets, such as government bonds from commercial banks, resulting in a flow of money from central bank to commercial banks.
This extra liquid cash can be used by commercial banks to make new loans to consumers and businesses, stimulating AD.
Though, money is created electronically and is likely to be inflationary.
What are the limitations of Monetary Policy?
The amount of spare capacity in the economy
Time lag
The amount of people on fixed rate mortgages or renting
Commercial and Retail banks may not pass on lower interest rates to consumers and businesses.
What is the base rate?
Thebase rate(also know as the bank rate) is the interest rate at which theCentral Banklends money tocommercial bankssuch as HSBC or Lloyds Bank
