Chapter 27 - Monetary policy

Define monetary policy

Define monetary policy

Refers to the use of interest rates, exchange rates and the money supply to control macroeconomic objectives and levels of economic activity.

Define money supply

Refers to the amount of money in the economy at a particular point in time

What are the 3 monetary policy mediums?

• Changes in interest rates

• Changes in money supply

• Changes in foreign exchange rates 

Explain 1 reason why the government might choose to reduce interest rates in the economy? 

The government chose to reduce the interest rates in the economy to make borrowing more attractive and to encourage consumption which will increase money supply. 

Explain the expansionary monetary policy:

Reducing interest rates will increase money supply and encourage spendings. This will cause employment and borrowing will be more attractive to households so they will spend more money since they have a higher disposable income.

Explain the contractionary monetary policy:

By increasing the interest rate, it reduces overspending and limits investment in the economy which reduces demands. This is used to reduce high inflation that may couse job losses in the long run. 

What are the effects of monetary policy measures on macroeconomic aims? 

• Expansionary monetary policy can boost household’s consumption as the cost of borrowing is reduced. (economic growth) 

• Expansionary monetary policy will lead to economic growth which will create more jobs  (low unemployment)

• Contractionary monetary policy will limit consumption in order to control the rate of inflation (low inflation) 

• Expansionary monetary policy will improve the international competitiveness of the country by reducing interest rates. (balance of payments stability)

What are 2 limitations of monetary policy?

• It takes time to see changes in the economy 

• Confidence levels of households might impact GDP due to the past