Monetary policy Flashcards
(23 cards)
What is monetary policy?
Government or central bank policy that uses interest rates, money supply, and exchange rates to influence AD and inflation.
Who controls UK monetary policy?
The Bank of England’s Monetary Policy Committee (MPC).
What is the main objective of UK monetary policy?
Price stability — keeping inflation close to the 2% CPI target.
What is the monetary policy instrument used most often?
The Bank Rate (official interest rate).
What is expansionary monetary policy?
Policy that lowers interest rates or increases money supply to boost AD.
What are the effects of lower interest rates?
Increases consumer spending, investment, weakens £, boosts exports → AD ↑
When is expansionary monetary policy used?
During a recession or when inflation is below target.
What are the risks of expansionary monetary policy?
May cause inflation, asset bubbles, or a weak currency → imported inflation.
What is contractionary monetary policy?
Policy that raises interest rates or restricts money supply to reduce AD.
What are the effects of higher interest rates?
Reduces borrowing, consumption, investment; strengthens £ → AD ↓
When is contractionary policy used?
When inflation is above target or the economy is overheating.
What are the risks of contractionary policy?
May cause recession, higher unemployment, low growth.
What is the interest rate transmission mechanism?
The process by which changes in interest rates affect consumption, investment, exchange rate, and therefore AD.
How do interest rates affect exchange rates?
Higher rates attract hot money inflows → stronger £
Lower rates reduce inflows → weaker £
How does the exchange rate affect AD?
A weaker £ makes exports cheaper and imports dearer → net exports ↑ → AD ↑
What is quantitative easing (QE)?
When the central bank creates money to buy financial assets, increasing liquidity and encouraging lending.
When is QE typically used?
When interest rates are close to zero and further cuts aren’t effective.
What are the risks of QE?
Inflation, asset price bubbles, rising inequality (rich benefit more).
What are limitations of monetary policy?
Time lags, low consumer/business confidence, liquidity trap, global shocks.
What is the liquidity trap?
When interest rates are so low that people prefer to hold cash and cuts no longer boost spending.
Why might lower interest rates not work during a recession?
Confidence is low, so households and firms may still save rather than spend.
How does monetary policy interact with fiscal policy?
They can work together or counteract each other — fiscal expansion may reinforce loose monetary policy.
What is the conflict between inflation and growth?
Policies that reduce inflation (e.g. raising rates) can slow growth, and vice versa.
