Monetary policy

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26 flashcards · Economics · by Addaneye

1. What is monetary policy?

   When the central bank manipulates the base interest rate or the money supply in order to influence aggregate demand

2. What is expansionary monetary policy?

   When the central bank decreases the base interest rate

3. What is the base interest rate?

   The interest rate the central bank chooses to lend to high street banks

4. What are the four ways in which changing the base interest rate affects the economy?

   Savings Mortgages Investment Net exports

5. The effect of a fall in the base interest rate on savings

   Fall in return on savings >> rise in marginal propensity to consume >> increase in consumption (65% of AD) >> outward shift of AD >> economic growth

6. The effect of a fall in the base interest rate on savings for pensioners (1 in 6 people)

   Fall in return on savings >> fall in disposable income >> fall in consumption (65% of AD) >> inward shift in AD >> fall in real GDP

7. The effect of a rise in the base interest rate on savings

   Rise in return on savings >> fall in marginal propensity to consume >> inward shift of AD >> fall in price level >>

8. The effect of a rise in the base interest rate on savings for pensioners (1 in 6 people)

   Rise in return on savings >> rise in disposable income >> increase in consumption >> increase in AD >> increase in price level

9. What is the wealth effect?

   An increase in the value of an individual's assets leads to an increase in consumption

10. The effect of a fall in the base interest rate on mortgages

    Fall in price of borrowing >> fall in cost of mortgages >> increase in demand for houses >> increase house prices >> increase in consumption due to positive wealth effect >> outward shift in AD >> increase in economic growth

11. Why is the positive wealth effect nearly non-existent in Europe (as shown by Richard Sousa)

    Increase in house prices >> increase in saving because most people (76%) don't own houses >> fall in consumption >> cancel out positive wealth effect

12. The effect of an increase in the base interest rates on mortgages

    Increase in cost of borrowing >> increase in cost of mortgages >> fall in demand for houses >> fall in price of houses >> fall in consumption due to negative wealth effect >> inward shift in AD >> fall in price level and real GDP

13. Why is the negative wealth effect nearly non-existent in Europe (as shown by Richard Sousa)

    Decrease in house prices >> fall in savings as most people (76%) don't own houses >> increase in consumption >> cancel out negative wealth affect

14. The effect of a fall in the base interest rate on investments

    Fall in cost of borrowing >> fall in repayments >> increase in borrowing by firms >> increase in investment (14% of AD) in capital >> outward shift in AD / outward shift in LRAS

15. When might lower base interest rates not increase investments

    When animal spirits are low, it becomes risky to invest in capital as it may not pay off

16. The effect of a rise in the base interest rate on investments

    increase in repayment >> fall in borrowing by firms >> fall in investment (14% of AD) >> inward shift in AD >> fall in real GDP & price level

17. How might a rise in base interest rates lead to a rise in inflation? (investments)

    Rise in repayment costs >> rise in costs for firms >> inward shift in SRAS >> rise in price level >> cost push inflation

18. What is contractionary monetary policy?

    When the central bank increases the base interest rate

19. The effect of a rise in the base interest rate on exports and imports

    Increase in return from savings >> increase in demand for pounds >> appreciation of pound >> imports cheaper / exports dearer >> inward shift in AD

20. Why may a rise in the base interest rate result in a rise in AD (exports and imports)

    UK is a net importer of raw materials >> cheaper imports >> cheaper raw materials >> decreasing costs for firms >> lower prices >> rise in international competitiveness >> increase in export revenue / decrease in import expenditure >> increase in AD / improvement of current account deficit

21. The effect of a fall in the base interest rate on exports and imports

    Fall in return on savings >> increase in supply of currency >> depreciation of currency >> imports dearer / exports cheaper >> fall in import expenditure / increase in export revenue >> outward shift in AD

22. Why may a fall in the base interest rate result in a fall in AD? (exports and imports)

    UK is a net importer of raw materials >> dearer imports >> dearer raw materials >> increase in costs for firms >> higher prices >> less competitive >> increase in import expenditure / fall in export revenue >> fall in AD / worsening of current account deficit

23. When is quantitative easing used?

    When the base interest rate can't be lowered any further

24. What is quantitative easing?

    When the central bank buys financial assets from high street banks to increase money supply and encourage lending

25. What are the two effects of quantitative easing?

    Increases the money supply of banks >> increase in lending >> increase in C & I >> outward shift in AD Increase in money supply >> depreciation of currency >> increase in net exports >> outward shift in AD

26. Negative effect of quantitative easing

    Increase in consumption and investment >> increase in AD >> increase in price level (inflation) & potentially hyperinflation