Macro essays

• Main tools of monetary policy

  • Changing base interest rates, quantitative easing
• Objectives of monetary policy for macroeconomic stability
• Monetary policy has been relatively successful in keeping inflation low and close to the government's target of 2% since the early 1990s
• A modest rise in interest rates can help to reduce inflationary pressure by increasing the cost of borrowing
• Monetary policy is operated by the Bank of England
• Objectives include meeting an inflation target of CPI 2% +/-1, maintaining stable and sustainable economic growth, achieving low unemployment, stable exchange rate, and manageable current account deficit
• When inflation rises above the government's target

  The Central bank can increase interest rates to reduce inflationary pressure
• Monetary policy involves attempts to control and influence the money supply and demand for money
• Independence from political pressures means people in the economy have more confidence that inflation will be low
• Higher interest rates

  Increase the cost of mortgage payments and loan repayments, leading to less disposable income for households and a cut back on consumer spending
• When inflation rises above the government’s target

  The Central bank can increase interest rates
• Monetary policy alone may be insufficient to ensure a return to normal growth
• The UK has avoided boom and bust cycles

  1992
• Full employment is a situation where everyone who wants employment is able to work
• Monetary policy has been fairly successful in keeping inflation close to the government’s target of 2%
• Inflation of 5% suggests that monetary policy is not guaranteed to keep macro-economic stability
• Full employment achieved by increasing aggregate demand


  Likely leads to inflation as firms face a shortage of workers and have to increase wages to attract workers
• Monetary policy has limitations in achieving several objectives at once
• Modest rise in interest rate

  Helps to reduce inflationary pressure by increasing the cost of borrowing and discouraging firms from investing
• The independent Central Bank has gained a reputation for keeping inflation under control
• Graph 2 shows inflation above the government’s target in 2008 and 2011 due to cost-push factors like rising oil prices, rising taxes, and devaluation
• Slowdown in consumer spending

  Reduces the rate of economic growth and demand-pull inflationary pressures
• Monetary policy focuses on keeping inflation at a target of 2%
• Monetary policy alone may not be sufficient to ensure stable economic growth
• Full employment means the economy is operating close to the production possibility frontier with no spare capacity
• Monetary policy is limited in its ability to prevent an asset bubble and ensure a quick economic recovery
• Bank’s decision to allow temporary cost-push inflation could be seen as the best way of achieving macro-economic stability due to difficult external circumstances
• Full employment leads to firms facing a shortage of workers and increasing wages to attract workers
• AD increasing faster than LRAS

  Implies economic growth without inflation
• Trade-off between full employment and current account on the balance of payments


  Rise in consumer spending and AD leads to a rise in imports and deterioration in the current account
• Increase in aggregate demand

  Initially doesn't cause much rise in prices
• Burst in economic growth


  May cause a rapid fall in unemployment
• Higher output leading to more demand for workers

  Results in a fall in unemployment
• Economic growth needs to be sustainable and not inflationary to achieve full employment without trade-offs
• Absolute poverty is defined as surviving on less than $2 a day
• Expansion of the export sector and investment-led growth

  Possible to achieve full employment without a deterioration in the current account
• Economic growth close to sustainable rate


  Enables the economy to get close to full employment without inflationary pressures
• Rapid rise in prices from P3 to P4


  Occurs when the economy is near full employment
• Productive capacity meeting the growth in aggregate demand

  Allows the economy to achieve full employment without inflation
• If there is structural unemployment, supply-side policies are needed to achieve full employment