Monetary Policy

Question 1

State + explain the macro effects of expansionary monetary policy.

Answer 1

• Growth: higher growth.
• Unemployment: lower - lower rates of cyclical unemployment.
• Inflation: higher demand-pull inflation.
• Trade / CA Position: via an increase in AD - X become less competitive - lower X revenue - worsening CA deficit. Plus, with higher growth + lower unemployment - higher incomes - more sucking in of M - worsening CA position. However, if i.r. are cut - leads to weaker exchange rate due to ‘hot money outflows’ from economy - actually see CA improvement.

Question 2

State + explain the micro effects of expansionary monetary policy.

Answer 2

• Impact On Savers: lower i.r. reduce rates of return on S. Those relying on S (i.e. pensioners, early retired, economically inactive, etc) - reduces living standards.
• House Prices: lower i.r. make it cheaper to borrow money - to get a mortgage + buy a house - increased D for houses - increasing house P - good for people who already have houses (increases wealth), however for those looking to buy a house - harder for them to access housing market.
• Firms Costs + Profitability: if they have loans, i.r. come down - lower CoPs - increases profitability.
• Impact On Indebted Households: if rates on loans are variable - reduces repayments + increases disposable income - improving living standards.

Question 3

State + explain the macro effects of contractionary monetary policy.

Answer 3

• Growth: lower growth.
• Unemployment: higher cyclical unemployment.
• Inflation: lower inflation.
• Trade / CA Position: if AD reduces, X more internationally competitive with lower rates of inflation. With lower growth + higher unemployment - less spending on M. However, ‘hot money inflows’ from higher i..r which appreciate currency - worsening of CA position.
• Reducing Systemic Risk: if i.r. are higher - reduces chance of systemic risk + bank failure + that spreading through banking sector. By raising i.r. - discourages amount of borrowing + debt - if lower - more S taking place - takes pressure out of banking sector - less chance of shock in economy - reduces chance of bank failure.
• Reducing Chance Of Credit / Asset Bubbles: raising i.r. - only those who can afford + need to borrow do so. Amount of lending / borrowing will be more sustainable - wont see so much borrowing being poured into asset markets - don’t get unsustainable rise of prices in assets.

Question 4

State + explain the micro effects of contractionary monetary policy.

Answer 4

• Impact on Savers: positive impact on savers.
• House Prices: potential fall in house P - concerns for those who have houses, but benefits for those who want to access housing market.
• Firms Costs + Profitability: firms who have loans with variable i.r. - increases CoPs - hurts profitability.
• Impact on Indebted Households: repaying loans with higher variable i.r. - harms living standards - could drive them to bankruptcy.