2.5 Monetary Policy Review/ Run-through
Name: Amrinder Chahal
Define Monetary Policy:
Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of
money supply and interest rate and is the demand side economic policy used by the government of a
country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
Interest Rates
Define Interest Rates:
The % put on loaned out money.
the proportion of a loan that is charged as interest to the borrower, typically expressed as an annual
percentage of the loan outstanding.
How does the interest rate mechanism work? i.e. when the interest rate is changed who changes it and
how?
The Bank of England determines the Interest rates for Banks and if then Banks loan out money again
they put their own interest rates upon it again so for example the government put a 2% interest rate on,
Banks will e.g. offer 2.6% to make their own profit as they also loan money from the Bank of England.
Just the bank of England can change the general interest rate but the banks can also adjust what they
offer.
Draw a D & S diagram for MONEY.
Where does interest rate appear/ represent on this diagram? How does the Central Bank (normally) affect
this diagram?
The interest rates represent the x-axis and the Central Bank effects this diagram by the money supply
and the amount of interest rates it charges upon the banks.
Central Banks:
Name the central bank of your country, the UK and the US of A.
Deutsche Bundesbank, Bank of England, The federal reserve
Central Bank Roles

implementation of monetary policy
o
Determining Interest rates,
o
Controlling Money Supply
If central banks are independent the government gives them goals that they must manage the
MP in order to achieve (which of our 5 Macro goals could they be set?)
Stable rate of Inflation,








banker to the government
o It is responsible for looking after the money received by the Government,
for example,
o
managing its payments, for example,
o
managers the national debt by
banker to the banks – lender of last resort-> lender of last resort
regulation of the banking industry
Monetary Policy and AD
Bonds:
Government issues bonds, for people to take bonds
AD Formula:
C+G+I+X-M
Expansionary, or Easy, Monetary Policy
Component
Consumer
AD
Spending
Expansionary Go up
Government Investment
Spending
Go up
Go up
Exports
Imports
Go down
Or go up as
with lower
interest
rates
currency
Go up
Why?
e.g. if
people need
to spend
less on
interest
rates they
can spend it
elsewhere.
Quantity of
easing ->
buying
bond. Helps
liquidity.
depreciates> goods get
cheaper->
more
exports
E.g. capital
People are
investment - going to put
> cheaper -> their money
more or
in banks in
bigger
other
investments countries
with higher
interest
rates on
their money
As with
more
money to
spend
people
could
import
more
Draw diagrams here for Expansionary, or Easy Monetary Policy.
 Increasing money supply by lowering interest rates
Why is the shape of the AS curve important again? !!
Contradictory, or Tight, Monetary Policy.
 Decreasing money supply to prevent inflation by e.g. increasing Interest rates
Component
Consumer
AD
spending
Expansionary Goes down
Why?
Government Investment
Spending
Goes down
Goes down
Exports
Imports
Goes down
Goes up
Draw diagrams here for Contradictory, or Tight Monetary Policy.
Why is the shape of the AS curve important again? !!
Monetary Policy and Inflation Targeting.
Read this – also on Firefly.
http://www.bankofengland.co.uk/monetarypolicy/Documents/pdf/chancellorletter080317.pdf
Who is the letter to? And what do they do?
To Mark Carney, governor of Bank of England
Who is it from? And what does he do?
HM treasury and he is the chancellor of the exchequer.
Does the Bank of England have an explicit or an implicit target to aim for? What is it?
Is the Bank of England Considered Independent?
Which of the 5 Goals does the BofE Focus on?
Which of the 5 goals does the Bank of England not interest itself in?
Can you see a problem?
Evaluate the effectiveness of monetary policy through consideration of factors including the
independence of the central bank, the ability to adjust interest rates incrementally, the ability to
implement changes in interest rates relatively quickly, time lags, limited effectiveness
in increasing aggregate demand if the economy is in deep recession and conflict among government
economic objectives.
Mind map these issues that we have considered here.