Monetary Policies

What is monetary policy

• It is the manipulation of money supply, interest rates, exchange rate, and the amount of credit available

• It can be used to promote economic stability, economic growth, and price stability

What is the central bank

• It is used to manage monetary policy

• Maintains price stability

• It can make monetary policy decisions without interference from politicians who might want to influence rates of interest for politically expedient reasons

What are interest rates

The price of money, the cost of borrowing and reward for saving

What does the monetary transmission mechanism do

Process by which a change in interest rates affects AD and inflation

Expansionary monetary policy

• Reduction in rates of interest reduces the cost of borrowing resulting in a rise in discretionary incomes

• Consumers are less incentivise to save

• A rise in discretionary income increases consumption causing AD to increase

• Consumption leads to an increase in imports which increases trade deficit on current account

Contractionary Monetary Policy

• An increase in interest rates will increase the cost of borrowing resulting in a reduction in discretionary incomes

• Consumers are incentivise to save

• A fall in discretionary income decreases consumption so AD decreases

• This leads to a decrease in imports decreasing trade deficit on current account

What is money supply

• It is the quantity of money in circulation in the economy in response to the 2008 financial crisis Bank of England used quantitative easing

What is quantitative easing

• The process by which liquidity in the economy is increased when the central bank purchases assets from a commercial bank

• Injecting money into economy can stimulate bank lending increase consumption and investment so greater economic output and reduce unemployment as derived demand for labour is less

What is symmetric inflation target

When fluctuations above the below the inflation target are equally weighted

What is asymmetric inflation target

When fluctuations above the inflation target are more significant than fluctuations below

What is hot money

Short term capital flow that responds to changes in relative interest rates

Effectiveness of monetary policy depends on

• Time lags

• Lack of targeting

• Business and consumer confidence

• The liquidity trap

• Monetary policy asymmetry