Monetary Policy- Interest Rates, Money Supply & Exchange Rate Flashcards
(23 cards)
What is monetary policy?
It’s the use of interest rates, money supply, and exchange rates by a central bank to influence aggregate demand (AD).
Who controls monetary policy in the UK?
The Bank of England, which is independent from the government.
What is the main target of UK monetary policy?
To maintain inflation at 2% (CPI target).
What is expansionary monetary policy?
Policies (like lowering interest rates) used to increase AD, raise inflation, boost growth, and reduce unemployment.
What is contractionary monetary policy?
Policies (like raising interest rates) used to reduce AD, lower inflation, and prevent asset/credit bubbles.
How can higher interest rates reduce excessive debt?
By increasing the cost of borrowing, they discourage taking on debt, making growth more sustainable and promoting saving.
Why might higher interest rates promote saving?
They offer a higher return on savings, providing an incentive for households and firms to save.
How do higher interest rates affect the current account?
They reduce AD, growth, and income, leading to lower import spending and potentially narrowing the current account deficit.
What is the transmission mechanism in monetary policy?
It’s the process by which changes in central bank interest rates affect spending, investment, and AD through various channels.
How do interest rate cuts affect consumer borrowing and spending?
They lower borrowing costs (e.g. credit card rates), making loans cheaper, which increases borrowing, reduces saving, and boosts consumption.
How do lower interest rates affect spending on big-ticket items like cars, furniture, and dwellings?
Lower interest rates reduce borrowing costs, encouraging people to spend more on these big purchases, boosting AD.
What happens to saving rates when central bank interest rates are cut?
Saving rates fall because the return on savings decreases, reducing the incentive to save and increasing the incentive to spend, which raises consumption.
How do lower mortgage interest rates affect household consumption?
Reduced mortgage payments increase households’ disposable income, raising their marginal propensity to consume and boosting consumption.
How do lower interest rates impact business borrowing and investment?
Lower borrowing costs encourage businesses to borrow more for investment, which increases AD.
How can lower interest rates affect the exchange rate and net exports (M-X)?
Lower rates reduce returns for savers, leading to capital outflows (hot money outflows), causing a weaker exchange rate, which can improve net exports and boost AD.
What happens to the currency when interest rates are cut?
The currency depreciates due to increased supply in foreign exchange markets as savers move money abroad.
How does a weaker currency affect exports?
It makes exports cheaper and more competitive internationally, boosting net exports and aggregate demand.
What is the effect of monetary policy on aggregate demand?
Expansionary monetary policy shifts AD to the right, increasing real GDP and price levels.
How can monetary policy indirectly affect long-run aggregate supply (LRAS)?
Lower interest rates reduce borrowing costs, encouraging investment that improves capital stock and productivity, shifting LRAS right.
What is the primary role of monetary policy?
To influence aggregate demand through changes in interest rates, money supply, and exchange rates.
Why might savers move money abroad when domestic interest rates fall?
To seek higher returns in countries with higher interest rates (hot money flows).
What happens to price levels and output when AD shifts right due to monetary policy?
Both price levels (inflation) and output (GDP) increase.
What is the central bank’s inflation target in the UK?
2%
