MACRO 11
MONETARY POLICY
Monetary policy is manipulating the supply of money in the economy in order to achieve
economic objectives
Not just interest rates
Evaluation
The real rates are significant
The real interest rate is the nominal interest rates minus inflation
If inflation rose from 5-6% but inflation rose from 2-5.5%
Represents a cut in real interest rates from 3-0.5%
In this circumstance the rise in nominal interest rates actually represents expansionary
monetary policy
Time lags
Can take up to 18 months to have an impact
Fluctuations in interest rates don’t have uniform impact on the economy
o Some industries are more affected than others
o Some regions are more sensitive
Markets which are most affected are those where demand is interest elastic when the
market demand responds elastically to a change in interest rates
o Interest sensitive industries are these directly linked to demand conditions in the
housing market, exporters of manufactured goods, construction industry and leisure
o Demand for basic foods and utilities is less affected by short term fluctuations in
interest rates
Decreasing interest rates and increasing the money supply has less impact than doing the
opposite
If consumer confidence is low the impact of monetary stimulus might be small
o People are more likely to save
If asset prices are falling the demand for cash savings will remain
Limits to how far monetary policy can go in boosting demand
o Nominal interest rates cant fall below zero
Interest rate cuts may not be passed on
o Especially if there is a cut in the base rate
Transmission mechanism
Changes in the interest rates alter the consumer price inflation
Evaluation
o Time lag
o Vulnerable
o BoE opting to not change interest rates
High street rates are not the same as interest rates
o Market interest rates
Banks make all their money from lending and changing interest rates
Banks are keen for increasing interest rates but not decreasing interest rates as they make
more money
The Bank of England changes the base rate set by the MPC (monetary policy committee)
o Market interest rates – savings rates and credit cards
o Asset prices – house prices
o Expectations and confidence
o Exchange rate – flows of hot money
, i. Affects import prices which affects consumer price/ cost push inflation
All of the above are affected by each other as well as the change in the base rate
Domestic demand – C + I + G
Net external demand – X - M
o Affects aggregate demand
i. Affects domestic inflationary pressure which affects consumer price/
demand pull inflation
Quantitative easing
1. Central bank creates money
2. It uses the new money to buy bonds from financial institutions including pension firms, non
financial companies, commercial banks
3. This leads businesses and people to borrow more
4. This reduces interest rates
5. More money is spent and jobs are created
6. This all boosts the economy
‘Printing money’
Commercial banks sell bonds to the Bank of England so they make more loans and charge
interest and lend this increase in money to the rest of the country which stimulates
investment and growth of the economy
Purchasing assets financed that the banks own electronically
Most assets purchased are government bonds
o There is a large market available so the bank can buy substantial quantities of assets
quickly
Higher asset prices also make some people better off which provides an extra boost to
spending on goods and services
The yield is the interest expressed as a proportion of the market price of the bond
Implemented in recessions or when there is deflation
o Financial crisis
o COVID-19 pandemic
Aim is to boost spending to keep inflation on track to meet 2% target
o Alongside its decisions on asset purchases the MPC continue to set bank rate each
month
Deflation is harder to solve
o Deflationary spiral
o Banks are more reluctant to pass on a cut in interest rates
o You can’t set negative interest rates
o There is low confidence in a deflationary economy – businesses are reluctant to
invest
Makes the price of bonds increase which makes people more willing to sell their bonds to
the government
o This makes the yield decrease on the bonds as the interest doesn’t change but the
price does
o Banks should switch into different financial products meaning there is an increase in
the amount of money and lenders available
The interest on debt is a key factor which affects people’s lending and spending
Evaluation
Higher asset prices lead to rising inequality as the people with many government bonds tend
to be those who are wealthier
MONETARY POLICY
Monetary policy is manipulating the supply of money in the economy in order to achieve
economic objectives
Not just interest rates
Evaluation
The real rates are significant
The real interest rate is the nominal interest rates minus inflation
If inflation rose from 5-6% but inflation rose from 2-5.5%
Represents a cut in real interest rates from 3-0.5%
In this circumstance the rise in nominal interest rates actually represents expansionary
monetary policy
Time lags
Can take up to 18 months to have an impact
Fluctuations in interest rates don’t have uniform impact on the economy
o Some industries are more affected than others
o Some regions are more sensitive
Markets which are most affected are those where demand is interest elastic when the
market demand responds elastically to a change in interest rates
o Interest sensitive industries are these directly linked to demand conditions in the
housing market, exporters of manufactured goods, construction industry and leisure
o Demand for basic foods and utilities is less affected by short term fluctuations in
interest rates
Decreasing interest rates and increasing the money supply has less impact than doing the
opposite
If consumer confidence is low the impact of monetary stimulus might be small
o People are more likely to save
If asset prices are falling the demand for cash savings will remain
Limits to how far monetary policy can go in boosting demand
o Nominal interest rates cant fall below zero
Interest rate cuts may not be passed on
o Especially if there is a cut in the base rate
Transmission mechanism
Changes in the interest rates alter the consumer price inflation
Evaluation
o Time lag
o Vulnerable
o BoE opting to not change interest rates
High street rates are not the same as interest rates
o Market interest rates
Banks make all their money from lending and changing interest rates
Banks are keen for increasing interest rates but not decreasing interest rates as they make
more money
The Bank of England changes the base rate set by the MPC (monetary policy committee)
o Market interest rates – savings rates and credit cards
o Asset prices – house prices
o Expectations and confidence
o Exchange rate – flows of hot money
, i. Affects import prices which affects consumer price/ cost push inflation
All of the above are affected by each other as well as the change in the base rate
Domestic demand – C + I + G
Net external demand – X - M
o Affects aggregate demand
i. Affects domestic inflationary pressure which affects consumer price/
demand pull inflation
Quantitative easing
1. Central bank creates money
2. It uses the new money to buy bonds from financial institutions including pension firms, non
financial companies, commercial banks
3. This leads businesses and people to borrow more
4. This reduces interest rates
5. More money is spent and jobs are created
6. This all boosts the economy
‘Printing money’
Commercial banks sell bonds to the Bank of England so they make more loans and charge
interest and lend this increase in money to the rest of the country which stimulates
investment and growth of the economy
Purchasing assets financed that the banks own electronically
Most assets purchased are government bonds
o There is a large market available so the bank can buy substantial quantities of assets
quickly
Higher asset prices also make some people better off which provides an extra boost to
spending on goods and services
The yield is the interest expressed as a proportion of the market price of the bond
Implemented in recessions or when there is deflation
o Financial crisis
o COVID-19 pandemic
Aim is to boost spending to keep inflation on track to meet 2% target
o Alongside its decisions on asset purchases the MPC continue to set bank rate each
month
Deflation is harder to solve
o Deflationary spiral
o Banks are more reluctant to pass on a cut in interest rates
o You can’t set negative interest rates
o There is low confidence in a deflationary economy – businesses are reluctant to
invest
Makes the price of bonds increase which makes people more willing to sell their bonds to
the government
o This makes the yield decrease on the bonds as the interest doesn’t change but the
price does
o Banks should switch into different financial products meaning there is an increase in
the amount of money and lenders available
The interest on debt is a key factor which affects people’s lending and spending
Evaluation
Higher asset prices lead to rising inequality as the people with many government bonds tend
to be those who are wealthier
