1. Monetary Policy and Demand Management

What are two factors that influence the value of money?

- Inflation

- Exchange rates

What is the Bank of England's role in managing the value of money?

They keep prices stable and maintain the value of money.

What is monetary policy?

Changes to interest rates, the money supply and the exchange rate by the central bank in order to influence AD.

What are market interest rates?

Interest rates you pay to borrow money.

What roles do banks perform? How?

Allow us to exchange money:

- Allow people to insure against risks in business and everyday life.

- Connects those who have money to save and invest to those who need money to borrow.

What is the main risk in the financial system?

Money may not be returned at all if things go wrong.

What do banks use to cover their risks?

- They monitor lending, spreading risks across loans in different sectors.

- They have a lot of capital in case anything goes wrong.

How does the BOE change the cost of money?

They set interest rates.

How long may it take for interest rates to impact the economy?

2 years.

What are interest rates?

The reward for saving and the cost of borrowing, expressed as a percentage of the money saved/ borrowed.

What are the 2 types of interest?

1. Interest on savings in the bank and other accounts.

2. Borrowing interest rates e.g. mortgage interest, credit card and pay day loans, government bonds.

Explain the transmission mechanism.

1. BOE changes base rates, impacting interest rates for borrowing and saving.

2. AD shifts due to change in spending, investment and exports.

3. Multiplier impact on consumption, jobs and investment.

4. Output will change depending on AS. (GDP)

It can take 12-24 months for full effects on GDP.

What are the two types of monetary policy?

1. Expansionary

2. Contractionary

What is expansionary monetary policy?

When there is a fall in nominal and real interest rates, expansion in supply of credit, and depreciation of the exchange rate to increase inflation.

What is deflationary monetary policy?

When there is higher interest rates on loans and savings, tightening of credit supply, and appreciation of the exchange rate to decrease inflation.

What does tightening of credit supply mean?

Loans become harder to access.

What is quantitative easing?

A process whereby a central bank purchases existing government bonds and private securities to increase the value of financial assets and add more money supply to stimulate the economy.

What is quantitative tightening?

When the bank sells bonds to banks to take money out of the economy to cool it down. (opposite of quantitative easing).

List some limits of monetary policy.

- Liquidity trap - may fail to stimulate the economy due to low confidence or banks not passing on base rates.

- Exchange rates may appreciate, causing less competitiveness

- Impact - may affects some parts of the economy more than others e.g. higher borrowers than savers

- Time lags

What is a benefit of monetary policy?

- Can help reduce cost-push inflation

- Can cause economic growth

- Encourages stability in the economy