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Monetary Policy
| Question | Answer |
|---|---|
| What is the role of the financial sector? | banks and other financial institutions are known as financial intermediaries. they provide a link between those who wish to lend money and those who wish to borrow. |
| What are the two types of banking systems? | Banks are divided into 1. Retail banking - such as high street banks operating bank accounts for individuals 2. Wholesale banking - they receive large deposits from and make large loans to companies, banks and other financial institutions |
| What is the function of the central bank? | Bank of England = UKs central bank. The European Central Banks is for those countries that use the Euro Its function is to issue notes, act as bank, over see the activities of other financial institutions, operate gov monetary policy and exchange rate. |
| What is monetary policy? | The process by which the monetary authority of a country controls the supply of money, often targeting an inflation rate or interest rate to ensure the stability of prices and general trust in the currency |
| Whats the the goals of monetary policy? | To contribute to economic growth and stability, low unemployment and a predictable exchange rate |
| What are the different relationships between the central bank and the government? | For most countries such as the UK the governments sets the monetary objectives and the central bank decided how to achieve them. For others the central banks may set and achieve the objectives or gov makes the objectives and directives the bank to achieve |
| What are the monetary policy objectives? | 1. Maintain stable prices 2. Achieve high and stable level of economic growth and employment |
| What are the functions of money? | Exchange; Storing wealth; Evaluation; Establishing the value of future claim/payment |
| What counts as money? | Cash - notes/coins Goods - e.g. fridges/cars/tomatoes does not count as money Broader definition of money also included some bank accounts and financial assets |
| How are stable prices maintained? | since 2004, specified target inflation rate of 2% per year as measured by the CPI Although inflation rate is reviewed annually. Intention is to look at a low and stable rate over the long term |
| How are high levels of economic growth achieved? | price stability is a key goal and major contributor to achieving other goals of gov policy. Price stability provide best environment for households and firms to make savings and investments. |
| Sometimes, the central banks has a trade off between what? | inflation and economic growth and employment. Actions that may reduce inflation and achieve stable prices might slow down the economic growth and employment |
| What are the two main benefits of adopting an inflation target? | 1. Purpose of the BoE policy actions more clearly understood in financial market 2. Target provides an anchor of expectation for future inflation. Helps individuals make better economic decisions helping achieve a more efficient allocation of resources |
| How does monetary policy affect interest rates? | the supply curve is inelastic. if the supply curve shift right this will increase interest rates. If the supply curve shift left, this will decrease interest rates. |
| What are the two types of monetary policy? | Monetary policy is referred to as either expansionary or contractionary |
| What is expansionary monetary policy? | Increases the amount of money in the economy, more rapidly than usual. traditionally used to combat unemployment in a recession by lowering interest rates (shift supply curve left) in the hope easy credit will encourage businesses to expand |
| What is contractionary policy? | Contractionary policy slows the amount of money that enter the economy more than usual. It is intended to slow inflation in order to avoid resulting distortions and deterioration of asset values. |
| How does Expansionary policy effect AD | Increase money supply --> lower interest rates --> Higher investment spending increases income --> Higher consumer spending --> Increased AD (AD curve shift RIGHT) |
| How does Contractionary policy effect AD | Decrease money supply --> Higher interest rates --> Lower investment spending decreases income --> Lower consumer spending --> Decreases AD (demand curve shifts LEFT) |
| What are the three tools central banks use to control monetary policy? | 1. Open-market operation 2. Reserve ratio 3. Discount rate |
| What does Open market Operation do? | Most important instrument for influencing money supply. Buying securities increases reserves of commercial banks. Excess reserves allow banks to expand the supply of money through loans. Selling securities reduces reserves, contraction of money supply. |
| What does the Reserve Ratio do? | Seldom used. Manipulation of ratio influences the ability of the commercial banks to lend. Increase ratio, amount of reserves that banks must keep with increase = less to lend. Lower the ratio, required reserves will decrease. = more money for lending |
| What the the discount rate do? | The interest rate the FRB charge on loans to commercial banks. Providing loans increases reserves of borrowing bank, enhancing ability to extend credit. For commercial banks, discount rate = cost of requiring those reserves. |
Created by:
Joph
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