Monetary Policy
Monetary policy: Change to interest rates, the money supply and
exchange rate by the central bank in order to influence AD.
Mandate of the Bank of England:
Government: Sets target of 2% inflation
Bank of England: Sets Interest rates Independently of the government.
Main aim of the central Bank is to control Inflation via controlling inflation
rates set by the government - 2% target.
BOE: Operates through the Monetary Policy Committee
- 9 members with 1 vote
- Bank of England governor - incharge of controlling inflation.
MPC:
- Large Team of economists and statisticians.
- Gathering data about AD and Full capacity of economy
- Calculate the output gap of the economy.
- Finds the Demand Pull and the Cost push Inflationary pressures.
- Develops Inflationary outlook for 2 years into the future - Probability
Fan.
- Finally, 9 Members vote to change interest rates
(up,down,unchanged).
Expansionary Monetary policy:
(policies to Increase AD)
1) Increase Inflation*
To raise demand pull inflation
2) Increase Growth
, 3) Reduce Unemployment
Interest rates are most important factor of Expansionary Monetary Policy
Transmission Mechanism of Expansionary Monetary Policy:
CENTRAL BANK INTEREST RATES ARE CUT
- There are many types of interest rates in an economy
- When the central bank interest rate is cut - Reduces interest rates in
different ‘channels’ of the economy.
Pros:
i) Credit Card Interest Rates Fall (lower borrowing costs for
consumers)
- Increased incentive to borrow
- Incentivises to not save
- Increases Marginal Propensity to consume as borrowing is cheaper -
bigger things bought (cars, houses) - Consumption Rises - AD rises.
ii) Saving Interest Rates Fall
- Lower rate of return on saving money in bank
- Reduces incentive to save
- Consumption increases
- AD increases
iii) Lower Mortgage Interest Rates
- Households that have variable rate mortgages - follow central bank
interest rates.
- Households pay l;ess monthly towards interest rate payments
- Increase disposable income
- Increase consumption - Increase AD
iv) Lower Interest Rates on Business Loans (SHIFTS LRAS AS WELL)
- Increases Incentive for business to borrow
- If business increase borrowing investment rises - Ad Increases
v) Weaker Exchange Rate
- Foreign Savers have less of an incentive to save in UK
- People move money out of country - ‘HOT MONEY’ OUTFLOWS
- Sell Pound
- Increase supply of pound in forex market
- Decrease Exchange Rate
Monetary policy: Change to interest rates, the money supply and
exchange rate by the central bank in order to influence AD.
Mandate of the Bank of England:
Government: Sets target of 2% inflation
Bank of England: Sets Interest rates Independently of the government.
Main aim of the central Bank is to control Inflation via controlling inflation
rates set by the government - 2% target.
BOE: Operates through the Monetary Policy Committee
- 9 members with 1 vote
- Bank of England governor - incharge of controlling inflation.
MPC:
- Large Team of economists and statisticians.
- Gathering data about AD and Full capacity of economy
- Calculate the output gap of the economy.
- Finds the Demand Pull and the Cost push Inflationary pressures.
- Develops Inflationary outlook for 2 years into the future - Probability
Fan.
- Finally, 9 Members vote to change interest rates
(up,down,unchanged).
Expansionary Monetary policy:
(policies to Increase AD)
1) Increase Inflation*
To raise demand pull inflation
2) Increase Growth
, 3) Reduce Unemployment
Interest rates are most important factor of Expansionary Monetary Policy
Transmission Mechanism of Expansionary Monetary Policy:
CENTRAL BANK INTEREST RATES ARE CUT
- There are many types of interest rates in an economy
- When the central bank interest rate is cut - Reduces interest rates in
different ‘channels’ of the economy.
Pros:
i) Credit Card Interest Rates Fall (lower borrowing costs for
consumers)
- Increased incentive to borrow
- Incentivises to not save
- Increases Marginal Propensity to consume as borrowing is cheaper -
bigger things bought (cars, houses) - Consumption Rises - AD rises.
ii) Saving Interest Rates Fall
- Lower rate of return on saving money in bank
- Reduces incentive to save
- Consumption increases
- AD increases
iii) Lower Mortgage Interest Rates
- Households that have variable rate mortgages - follow central bank
interest rates.
- Households pay l;ess monthly towards interest rate payments
- Increase disposable income
- Increase consumption - Increase AD
iv) Lower Interest Rates on Business Loans (SHIFTS LRAS AS WELL)
- Increases Incentive for business to borrow
- If business increase borrowing investment rises - Ad Increases
v) Weaker Exchange Rate
- Foreign Savers have less of an incentive to save in UK
- People move money out of country - ‘HOT MONEY’ OUTFLOWS
- Sell Pound
- Increase supply of pound in forex market
- Decrease Exchange Rate
