4.4 - Monetary policy
4.4.1 Definition of money supply and monetary policy
Definition
● Monetary policy is a demand side policy whereby the central bank will change
various money variables to influence the level of economic activity (change
rGDP) in a country
Money variables for monetary policy
1) Interest rate
2) Money supply
a) Amount of money in circulation (determined by central bank)
b) Supply is perfectly inelastic - bc determined by central bank and NOT
price
3) Foregin exchange rates
● Monetary policy is when the central bank changes the above to influence
economic activity
4.4.2 Monetary policy measures
Interest rate
THE COST OF BORROWING
● Issued by central bank
● Not from loans, etc
Expansionary monetary policy
● This involves a ‘loosening’ of the monetary
policy where the central bank will reduce the
interest rate and/or expand the money
supply to boost economic activity in a country
● By reducing interest rates:
○ Less incentive to save, so it can boost
consumption
○ Borrowing is cheaper for businesses, so it
encourage investment
4.4.1 Definition of money supply and monetary policy
Definition
● Monetary policy is a demand side policy whereby the central bank will change
various money variables to influence the level of economic activity (change
rGDP) in a country
Money variables for monetary policy
1) Interest rate
2) Money supply
a) Amount of money in circulation (determined by central bank)
b) Supply is perfectly inelastic - bc determined by central bank and NOT
price
3) Foregin exchange rates
● Monetary policy is when the central bank changes the above to influence
economic activity
4.4.2 Monetary policy measures
Interest rate
THE COST OF BORROWING
● Issued by central bank
● Not from loans, etc
Expansionary monetary policy
● This involves a ‘loosening’ of the monetary
policy where the central bank will reduce the
interest rate and/or expand the money
supply to boost economic activity in a country
● By reducing interest rates:
○ Less incentive to save, so it can boost
consumption
○ Borrowing is cheaper for businesses, so it
encourage investment
