12.3 Central Banks and Monetary Policy

What are the core roles of a central bank in an economy

Managing the currency, money supply, and interest rates; issuing secure currency; regulating bank lending to maintain financial stability

How does the central bank act as a banker to the government

It collects and makes payments for the government, manages public debt, and advises on finance and loan terms

What does it mean for a central bank to be the "lender of last resort"

It provides liquidity to banks in distress to prevent collapse and restore confidence, potentially avoiding a bank run

What are the key elements central banks influence through monetary policy

Interest rates, money/credit supply, and the exchange rate

Who conducts monetary policy in the UK and since when has it been independent

The Bank of England, independent since the 1990s

What is the primary objective of the UK monetary policy

To maintain price stability, targeting a 2% inflation rate (CPI)

What if the MPC and how often does it meet

The Monetart Policy Committee, comprising 9 members, meets 8 times a year to set interest rates

What is the base the rate and how does it affect the economy

The interest rate the BofE sets for lending to other banks, influencing commercial interest rates

How does the MPC use interest rates to meet inflation target

By raising or lowering the bank rate to influence borrowing, spending and inflation

What would high unemployment lead the MPC to do

Cut interest rates to boost consumer spending and stimulate economic growth

How does the savings rate influence MPC decisions

High savings imply low spending, prompting possible rate cuts to encourage consumption

How do high commodity prices affect interest rate decisions

They may prompt increases in interest rate to counteract cost-push inflation

How does exchange rate impact the MPC

A weak pound increase import costs and inflation, potentially leading to base rate increase and vice versa

What is the effect of a falling exchange rate on exports and import

Exports rise (cheaper), Imports fall (more expensive), improving the current account

Why can weaker exchange rate be inflationary

It raises import prices, leading to cost-push inflation

What is the “hot money” effect in relation to interest rates and exchange rates

Higher UK interest rates attract investment, increasing demand for the pound and causing appreciation

What is the monetary transmission mechanism

The process where interest rates changes affect consumer behaviour, investment, exchange rates and AD

What is quantitative easing (QE)

A method where the BoE buys large quantities of financial assets, like government bonds, from financial institutions, effectively injecting liquidity into the banking system

How does QE affect inflation and currency value

It can cause inflation and depreciate the currency due to increased money supply

What is forward guidance in monetary policy

A strategy where central banks communicate future policy plans to reduce market uncertainty