Monetary Policy
Monetary policy consists of the actions of a central bank that determine the size and rate of
growth of the money supply, which in turn affects interest rates
Expansionary Deflationary
Fall in real and nominal interest rates High interest rates on loans and savings
Measures to expand the supply of credit Tightening of credit supply
Depreciation of the exchange rate Appreciation of the exchange rate
Factors considered when setting rates:
• GDP growth and spare capacity
• Bank lending, consumer credit and retail sales
• Share and house prices
• Consumer and business confidence
• Wages, labour and productivity
• Unemployment
• Exchange rates
• International data
• Trade
Distribution of wealth and cuts:
• Savers will lose money
• Homeowners gain
• Unsecured debt becomes cheaper
Evaluation of a cut in rates:
• Commercial banks may be unable or reluctant to lend
• Credit card rates may remain high
• High stock of personal debt may hold back demand
• Fall in income for savers
• Low business or consumer confidence after recession
Transmission Mechanism
• Change in market interest rates
Takes 12 to 24 months for
interest rate changes to have an • Impact on demand
impact on GDP and inflation
• Effect on output, jobs and investment
• Effect on real GDP and inflation
Monetary policy consists of the actions of a central bank that determine the size and rate of
growth of the money supply, which in turn affects interest rates
Expansionary Deflationary
Fall in real and nominal interest rates High interest rates on loans and savings
Measures to expand the supply of credit Tightening of credit supply
Depreciation of the exchange rate Appreciation of the exchange rate
Factors considered when setting rates:
• GDP growth and spare capacity
• Bank lending, consumer credit and retail sales
• Share and house prices
• Consumer and business confidence
• Wages, labour and productivity
• Unemployment
• Exchange rates
• International data
• Trade
Distribution of wealth and cuts:
• Savers will lose money
• Homeowners gain
• Unsecured debt becomes cheaper
Evaluation of a cut in rates:
• Commercial banks may be unable or reluctant to lend
• Credit card rates may remain high
• High stock of personal debt may hold back demand
• Fall in income for savers
• Low business or consumer confidence after recession
Transmission Mechanism
• Change in market interest rates
Takes 12 to 24 months for
interest rate changes to have an • Impact on demand
impact on GDP and inflation
• Effect on output, jobs and investment
• Effect on real GDP and inflation
