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Economics
Monetary policy
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Cards (32)
Monetary policy
A
policy that aims to control the
total supply
of
money
in
the
economy
to
try
to
achieve
the
government's
economic
objectives,
in
particular
price
stability
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The
major objective of monetary policy is a
low
and
stable
rate
of
inflation
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Monetary Policy Committee (
MPC
)
Operates
monetary
policy
in the UK
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In the UK, the target is to keep inflation at
2%
per annum (+/-
1.5%
)
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Bank rate
The
Bank of England
uses its bank rate to influence all other
interest rates
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Monetary policy attempts to limit
total
demand
for
goods
and
services
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Interest rates
The main tool of
monetary
policy
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In recent years
quantitative
easing
has been used to get more
money
into the economy to encourage
consumption
and
investment
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How monetary policy changes interest rates to achieve economic objectives
1.
Reduced
interest rates
2.
Increased
spending
and
borrowing
by
consumers
3.
Increased
borrowing
for
investment
by
firms
4. UK
exchange rate
falls
5. Increased
economic
growth,
employment
and price stability
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When
interest rates
fall
Spending
and
borrowing
by
consumers
increases
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When interest rates fall
Borrowing
for
investment
by firms
increases
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When
interest rates
fall
UK exchange rate
falls
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When interest rates rise
Spending
and
borrowing
by consumers decreases
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When interest rates rise
Borrowing
for
investment
by firms decreases
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When
interest rates rise
UK exchange rate rises
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The effects of monetary policy on
consumer
spending
depend on the
size
of
the
change
in
interest rates
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The
larger
the
change
in
interest rates
, the more
consumer spending
is likely to be affected
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The UK's large
mortgage
sector tends to magnify the effects of changes in
interest rates
on consumer spending
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Effects of a fall in interest rates on consumer spending
Opportunity cost
of
spending
falls, so consumers spend more and save less
Increase in
disposable income
for
mortgage owners
, so they can spend more
Retired
people who rely on
income
from savings may spend less as their income falls
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The
opposite
effects will occur for a rise in
interest rates
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Consumers borrow
more
to buy
big-ticket
items when
interest rates
fall
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A fall in
interest rates
may not lead to more
borrowing
if consumers lack confidence in the economy
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More people can afford to buy
houses
or larger houses when
interest rates
fall
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Effects of a fall in
interest rates
on saving
Consumption
should rise and savings fall as the
opportunity cost
of consuming is less
If prices are falling, a cut in
interest rates
may not affect
savings
as people can consume more due to the price change
If the real rate of
interest
still exceeds the rate of inflation, people may save more as the value of
savings
is rising
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Factors affecting investment
Expected return from the
investment
State of the
economy
Competitors'
investment
decisions
Taxation on
profits
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Monetary policy and economic objectives
The main tool is
interest rates
In recent years
quantitative
easing has been used to put more money into the economy to encourage
consumption
and investment
View source
How monetary policy can affect growth
1.
Spending
and
borrowing
by consumers increases
2.
Borrowing
for investment by firms
increases
3. UK exchange rate
falls
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How monetary policy can affect employment
1. Spending and
borrowing
by consumers
increases
2.
Borrowing
for investment by firms
increases
3.
UK exchange rate
falls
View source
How monetary policy can affect price stability
1.
Spending
and
borrowing
by consumers decreases
2. Borrowing for
investment
by firms decreases
3.
UK exchange rate rises
View source
Effects of a fall in interest rates on borrowing
Consumers borrow
more
to buy 'big ticket' items
If consumers lack confidence, a cut in
interest rates
may not lead to
more
borrowing
More people can afford to buy houses or to buy
larger
houses
View source
Effects of a fall in
interest rates
on
savings
Consumption should rise and savings fall
If
prices
are falling, a cut in
interest rates
may not affect savings
If the real rate of
interest
still
exceeds
the rate of inflation, people may save more
View source
Effects of monetary policy on investment
Two sources of money for investment are
loans
and
retained profits
Other factors affecting investment: expected returns, state of the economy, competitors,
taxation
on
profits
View source
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