Monetary policy 😮

• Monetary policy


  The use of interest rates, the supply of money and exchange rates by the Bank of England to achieve the government's main objectives
• Monetary policy objectives


  • Expansionary monetary policy
  • Contractionary monetary policy
• Forward guidance


  Central bank publicly announcing its intentions to keep the lending rate to commercial banks below a certain level for a set period of time or rules
• Funding for Lending (launched in 2012)= B of E lending money to commercial banks below market rates (intention that cheap loans passed on to consumers and firms)
• Quantitative easing


  The central bank buying bonds from financial institutions to increase the money supply
• Interest rates


  The reward for saving and cost of borrowing expressed as a percentage
• Real interest rate


  Adjusted for inflation (minus the inflation rate)
• Nominal interest rate


  Reflects current market conditions (not adjusted for inflation)
• Interest rates take 18-24 months to fully create impacts
• Factors considered when setting interest rates


  • Wage growth
  • GDP growth
  • Output gap
  • Unit labour costs
  • Bank lending
  • Equity market prices
  • Unemployment
  • Trends in global factors
• Most banks have similar interest rates to the base rate because it is a competitive market
• Different interest rates


  • Interest rates on savings in banks
  • Mortgage rates, credit card rates, payday loan rates, corporate bond rates
• Liquidity trap


  When low interest rates and high cash balances in the economy fail to stimulate aggregate demand
• How quantitative easing works


  1. Central bank buys bonds from financial institutions

  2. Increases money supply

  3. Reduces bond yields

  4. Increases liquidity

  5. Encourages lending
• Very low interest rates


  Can distort capital allocation, cause wealth inequality, and keep zombie companies alive
• Exchange rate


  The value of one currency for the purpose of commerce in relation to another currency
• Types of exchange rate regimes


  • Floating exchange rate
  • Fixed exchange rate
• Appreciation of a currency


  Increase in the value of one currency in relation to another currency
• Depreciation of a currency

  Decrease in the value of one currency in relation to another currency
• Weak currency


  Leads to higher inflation, improved trade balance, and real GDP growth
• Factors affecting a currency's value

  • Trade balances
  • Capital flows (FDI, portfolio investment)
  • Interest rate differentials
• The UK operates with a floating exchange rate regime
• Falling exchange rate


  Initially worsens the trade balance, but eventually improves it (J-curve effect)