87392
Monetary Policy
- Definitnon
- managing the
economy through
influencing the
supply of money, int
rates and QE
- managing the
economy through
influencing the
supply of money, int
rates and QE
- What is it
- Money is an asset.
- Short run compared to fiscal policy. However a long term effect
is desired. changed monthly
- demand is interest elastic
- Money is an asset.
- How interest rates affects AD
- interest rates can be increased or decreased in order to
control AD.
- If interest rates^ then AD down. Want to cool
economy
- Firms spend less on
investment, due to
borrowing cost
being high, AD falls,
MPS^,
- household consumption down, 60%
of AD, fall in inflation, controlling
inflation is main aim
- Firms spend less on
investment, due to
borrowing cost
being high, AD falls,
MPS^,
- Low interest rates mean that businesses have more disposable income to
reinvest profits to expand to grpwth. allows for unemployment to
decrease=help stable the economy as inflation low too.
- Low int in UK 2009-2012, credit crunch bite business
and consumer confidence. 0.5% in 2009 in response
to deepening recession and fears of deflation.
Therefore deliberately low to try boost AD and
output.
- This is not working because inflation too ^ so no effect
on £ and disposable income ( prices ^ due to oil )
- This is not working because inflation too ^ so no effect
on £ and disposable income ( prices ^ due to oil )
- interest rates can be increased or decreased in order to
control AD.
- Does it control
inflation/unemployment/Bop/GDP?
- low int rates so ^ consumer
MPC, buy more , AD^
- firms expand-employ
more= unemployment
down
- firms expand-employ
more= unemployment
down
- EXCHANGE RATE
- ^interest rates compared to
USA and Japan= attracts 'hot
money' flows into financial
system.
- Leading to strong £= ^ imports,
decrease in exports (appear more
expensive, less competitive)
therefore worsening of BOP
- Leading to strong £= ^ imports,
decrease in exports (appear more
expensive, less competitive)
therefore worsening of BOP
- ^interest rates compared to
USA and Japan= attracts 'hot
money' flows into financial
system.
- low int rates so ^ consumer
MPC, buy more , AD^
- QE
- Govnt giving
£ to banks
- try to encourage
banks to lend to
^ consumer
confidence
- try to encourage
banks to lend to
^ consumer
confidence
- Creating/ priniting
more £ so =
hyperinflation
- Govnt giving
£ to banks
- what are interest rates
- there are thousand of
interest rates in the
financial, not the same
in all banks and
building societies.
- base rate 0.5% acts as a guide.
- Not the same in
all banks and
building socities
- Real rate of interest is important to
businesses and consumers when making
spending and saving decision.
- Real rate of return on savings=money rate of interest-rate of inflation
- Factors considered when setting interest rates 1) GDP
growth and spare capacity 2)bank lending and consumer
credit figures 3) equity markets and house prices-inflation
been criticized for not doing enough to prevent the
housing bubble on 2008.4) consumer + business
confidence 5) growth of wages, avg earnings and unit labor
costs 6) unemployment figures 7) trends in gloabal foreign
exchnge markets(exchnge rate)7) international data
(developments in emerging market countries and US and
Japan)
- Main effects of a change in exchange rate : 1) transmission mechanism of monetary policy
(knock on effect) 2) lending(cheap) and borrowing (expensive) rates. Banks and building
societies will have similar rates due to competition. if int rate ^ then they will also ^ charges
on loans and interest they offer
- there are thousand of
interest rates in the
financial, not the same
in all banks and
building societies.
- Conclusion
- reduction in int rates or
^ in supply of £ and
credit in economy is
called EXPANSIONARY
MONETARY POLICY/
RELFATIONARY
MONETARY POLICY
- ^ in int rates / attempts to control or
reduce supply of £ and credit is called
CONTRACTIONERY MONETARY
POLICY/DEFLATIONARY MONETARY
POLICY
- Over last few decades monetary policy
has been main policy instrument for
managing level and rate of growth of
AD and inflationary pressures (since
1997)- HOWEVER the new gov is using
more fiscal to reduce defecit.
- reduction in int rates or
^ in supply of £ and
credit in economy is
called EXPANSIONARY
MONETARY POLICY/
RELFATIONARY
MONETARY POLICY
- Why has low int rates not boosted AD?
- unwillingness of
banks to spend
- low consumer conf,
weak expectations,
lower effect of rate of
changes on consumer
demand- i.e low
interest elasticity of
demand.
- huge levels of debt still need to be paid off including over £200bn on credit cards
- falling/slow ^ in asset prices make it unlikely tht cheap
mortgages will provide immediate boost to housing market.
- int rates close to 0 BUT real rate of int
charged on loans and overdrafts has ^,
cost of borrowing/bank loans is high
multiple of policy rate( not same for
every bank/building society)
- unwillingness of
banks to spend
- Summary
- Mortgage payers have less int to pay- ^
disposable income
- Businesses under
less pressure to meet
int payments on loans
- Cost of consumer credit should
fall encouraging purchase of big
ticket items suc h as new car
- Lower int rates
might cause a
depreciation of
sterling thereby
boosting
competitiveness
of export sector
- Lower rates are designed to
boost consumer and business
confidence
- Mortgage payers have less int to pay- ^
disposable income
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