Monetary policy

• Monetary policy involves changes in interest rates, the supply of money & credit and exchange rates to influence the economy $x$
• What is used?

  • market interest rates
  • bank lending
  • currency markets
  • inflation targets
  • bank of england
  • European Central Bank
• What are interest rates?

  The reward for saving and the cost of borrowing expressed as a percentage of the money saved or borrowed
• Types of interest rates:

  • interest rates in savings in banks and other accounts
  • borrowing interest rates

  -mortgage interest rates

  -credit cards intrest rates and pay-day loans

  -interest rates on government and corporate bonds
• Expansionary monetary policy?


  Fall in annual nominal and real interest rates

  Measures to expand supply of credit

  Depreciation of the exchange rate
• Deflationary monetary policy:

  • higher interest rates on loans and savings
  • tightening of credit supply (loans are hard to get)
  • appreciation of the exchange rate
• The monetary policy can do lots, one change will often harm another factor of the economy. There is a time lag of roughly 18 months before these strategies take affect
• Negative interest rates:

  • The real rate on savings in the money rate of interest minus the rate of inflation
  • Real interest rates become negative when the nominal rate of interest is less than inflation
  • Price deflation can lead to an increase in real interest rates
• Transmission mechanism of monetary policy:

  1. Change market interest rates
  2. Impact on demand
  3. Effect on output jobs + investment
  4. Real GDP and price inflation
• What is Quantitative easing?

  QE involves us buying bonds to push up their prices and bring down long-term interest rates. In turn, that increases how much people spend overall which puts upward pressure on the prices of goods and services
• Has QE worked?


  The case for Bank of England:

  • avoided a damaging depression
  • avoided sustained deflation
  • more competitive currency helped
  • hasn’t raised interest rates too early
• Why hasn’t QE worked?

  • Inflation went well above target in 2008 and 2012
  • Signs of another unsustainable housing boom
  • Low interest rates have become less effective
  • Britain has record current account deficit
• Benefits of low interest rates:

  • helps maintain consumer + businesses confidence
  • the pound would appreciate
• Drawbacks of low interest rates:

  • savers hit badly - assets rich but cash poor
  • people may borrow more than needed
  • no savings
  • possible inflation