Macro policies

Example of expansionary monetary policy

After 2008 financial crisis - BoE bought government bonds to increase money supply and lending.

Pros of UK using EMP

• Lowered borrowing costs

• The “wealth effect”

• Supported businesses confidence

Cons of UK using EMP

• Increased wealth inequality

• Reduced returns for savers

• Pension fund defecits

Pros of EMP

• Boosts consumption

• Prevents deflation

• Reduces unemployment

Cons of EMP

• Time lags: takes 12-18 months for it to come into effect

• Reduced saving incentive

• Reliant on the output gap

How does EMP work

• Increased money supply + QE → falling interest rates → saving less attractive → borrowing cheaper → mortgage interest fall → greater demand for houses → higher house prices → positive wealth effect → demand for businesses borrowing and investment falls → exchange rate of pound falls → exports increases

How does CMP work?

Money supply decreases + QT → Interest rates rise → demand for pound rises → value of pound rises → price of exports rise → demand for exports fall → price of imports fall → demand for imports rise

Pros of CMP

• Value of pound increases

• Price stability

Cons of CMP

• Demand for imports to rise

• Reduced AD

• Increased unemployment

Example of CMP

The Volcker Shock (1979-1982)

Pros of the volcker shock

• By 1983, inflation had fallen to 4%

• The “Great Moderation” 20 years of low inflation

Cons of the volcker shock

• Severe recession

• Unemployment up to 10.8% in 1982