| What does Monetary Policy involve? | -Setting Interest Rates
-Money Supply [In Circulation and in Bank Accounts]
-Exchange Rates
-A Demand Side Policy - Affects AS |
| How can Interest Rates affect the Economy? | -Borrowing, Savings..
-Spending and Investment
-Money Supply and Exchage Rate |
| What is Contractionary and Expansionary Monetary Policy? | -CONTRACTIONARY Monetary Policy is Reducing AD via Higher Interst Rates, Restrictions on Money Supply and Strong Exchange Rate
-EXPANSIONARY Monetary Policy is Increasing AD by doing the Exact Opposite as Above |
| What does Monetary Policy aim for? | -Price Stability and Economic Growth |
| Who sets Interests Rate in the UK | -The Monetaary Policy Committee [MPC] of the Bank of England.
-They do this in order to keep Inflation at 2% [CPI] If Inflaation goes above, they Increase tthe % Rate |
| Why is having Inflation at 2% so Key for UK Economy? | -Low, Stable and Credible Inflation will not alalow High Rates of Inflation to be Embedded.
-Macroeconomic Stability also prevetns Uncertainity, Encouraages Investment and makes it hard to Plan for the Future |
| The Bank of England is Independent and Accountable. Why does this help keep Inflation Stable and Trustworthy | -Indepdence makes sure the Government can’t use the % Rate for Political Reasons, like Win Votes
-Accountable ensures the Bank has to write a Letter to the Chancellor why and how the MPC will deal with Inflation if theres 1% Difference to their Target |
| What Factors will the MPC Consider when setting Interest Rates [Not Just Inflation] | -House Prices
-Size of Output Gaps
-Pound’s Exchange Rate
-Rate of any Increase or Decrease in Average Earnings |
| Interest Rates have been Increased.
-Name some of the Ripple Effects | -Less Borrowing
-Less Spending via Firms and Consumers
-Less Confidence & Animal Spirts
-Decrease in Exports, Increase in Imports |
| What is a Liquidity Trap? | -When the Population feels Pessimstic and unhopeful for the Economy’s Future, they will Hold on to the Money and not Borrow more. Therefore the Lowering Interest Rates will not cause Ripple Effects [More Consumption, More Confidence..] meaning Monetary Policy is Useless |
| What is the Bank Rate? | -This is the Lowest Rate that the Bank of England will Lend to Financial Insitituions [Banks]
-This IS NOT the rate that Mortgages or Loans that Citizens get |
| How does the Bank Rate influence the Interest Rate on Citizens? | -If the Bank Rate Increased, it becomes more Expensive for Banks to Borrow, so they will raise their Interest Rates to discourage Borrowing and Encoruage Savings [Deposits]
-The Opposite is the Same - Low Bank Rate, More Cheap to Borrow, Lower % Rates |
| How can the Avalibility of Credit to Banks influence Interest Rates? | -Banks need to Borrow in order to Lend basically. If Tons of Banks are doing that, then they will pay a Higher Rate, meanng the Cost of Mortgages and Loans will Increase as well |
| Why can High Interest Rates affect the Exchange Rate? | -Big Financial Insitutions [Banks, Insurance..] will Buy the Pound and save it in British Banks to take part in the High Reward Savers would get. This is an Example of ‘Hot Money’ |
| Why can High Exchange Rates make British Beef more Expensive?
[Say £1=$2 —> £1=$4 and that Beef is £1] | -To buy the Beef, Americans must Buy the Pound, so thus, the Beef is $2.
-And if the Exchange Rate goes up, £1 = $4, then Americans must spend more $$ to get British beef.
-Crucial to Remember that the Beef in Britain hasn’t Changed. This Cost to Americans is because the £ is Stronger |
| So what way do Interest Rates go to Improve the Balance of Payments? | -Interest Rates must Decrease. This will make Imports more Expensive and Exports more Cheaper |
| What is the Transmission Mechanism? | -This is a Large Diagram, that simple shows off the Ripple Effects that occur when the Bank Rate changes. |
| Using the Transmission Mechanism, What happens when Bank Rates tanks? | -Other Interest Rates, Mortgages and Savings, will Fall as a Result [Cheaper to Borrow]
-Asset Prices [Houses and Shares] will Increase as it will be Bought more due to the Borrowing Increase
-This also makes the Exchange Rate Fall, meaning Exports Increase. Overall, AD Increases
-Import Prices will Increase, and Inflation will also Increase as well |
| Why does the MPC need to look 2 Years into the Future for Interest Rates? [Use % Rates Falling] | -Reducing Interest Rates won’t cause an AD Surge
-Firms will Plan Investment Projects Carefully - so Months or Years until they Spend
-House Buyers need Time, as People need to Look Around for a Home, and actually Finalise the Purchase. Fixed Rate Mortgages won’t feel anything until the Fixed Rate Period ends |
| What are the Time Lags for Firms and Consumers in terms of Response to Bank Rate Changes | -Maximum Effect for Firms is felt after 1 Year
-Maximum Effect for Consumers is felt after 2 Years |
