Download Monetary-Policy

Monetary Policy
• A demand-side policy – shifts AD
(secondarily affects AS)
1. Changes in short-term interest rates to
influence the level of AD & inflation
2. Quantitative Easing (QE)
Economic Effects of
Interest Rate Changes
Exchange Rate
Housing Market
Credit Demand
Interest rate changes
will impact:
Investment
Saving
Monetary Policy Committee
• MPC has 9 members
– Governor plus 4 from the Bank of England (including 2 Deputy
Governors)
– 4 external members appointed by the Chancellor
• The MPC set interest rates every month in order to meet
their mandate from the chancellor of the exchequer:
“inflation must be at 2%”
(if inflation is below 1% or above 3%, the MPC must
explain why in an open letter to the Chancellor)
• Economic data is considered to assess the potential of
each indicator to impact inflation
What do the MPC look at when deciding if
inflation might become too high / too low…
Exchange Rate
Rate of GDP Growth
Wage Inflation
Housing Market
Credit Demand
Economic data
for consideration
Unemployment
Investment
Manufacturing Output
Retail Sales
MPC must consider all these things in the economy to assess the inflationary
pressure that is likely – decide whether they need to change interest rates to
achieve 2% inflation target.
Economic
indicator
How it will affect inflationary expectations…
Investment
If it is rising, then this will increase AD in the short run, causing Demand-Pull inflation. (In the longer
term, it might lower production costs through greater efficiency reducing inflation again if AS shifts out)
If it is falling then…
Unemployment
If it is rising, then…
If it is falling then…
Housing Market
If it is rising, then…
If it is falling then…
Rate of GDP
Growth
If it is high, then…
Exchange Rate
If it is rising, then…
If it is low then…
If it is falling then…
Wage Inflation
If it is high, then…
If it is low then…
Credit Demand
If it is rising, then…
If it is falling then…
Manufacturing
Output
If it is rising, then…
Retail Sales
If it is rising, then…
If it is falling then…
If it is falling then…
Advantages of
Lower Interest Rates
• Cheaper for businesses to finance capital investment long-run economic growth
• Households enjoy cheaper loans for homes, cars, etc –
boost to C
• Easier to start new businesses – source of long-run growth
• Reduced interest burden on the national debt for the
Government - reallocate spending
• Currency may fall
Disadvantages of
Lower Interest Rates
• Disincentive to save – (savings needed to
finance investment, education, etc)
• Retirees may see incomes fall
• Credit boom may fuel rising inflation
• Currency may fall
Quantitative Easing
• Used when interest rates are already low and AD
still needs stimulating
• Bank of England creates new money electronically
• B of E buys bonds from financial institutions (eg.
pension funds, commercial banks)
• Commercial banks have more cash to lend out to
customers
• ↑ money available for lending → ↓ interest rates →
↑C & I → ↑AD
Criticisms of Monetary Policy
• Difficult to assess state of the economy based on
monthly data
• Time lags – takes up to two years for effects to be fully
realised in the economy
• Effects on currency may be undesirable
• One size fits all – needs of one sector may be opposite
to those of another – can’t be targeted at problem areas
• May not be effective if already anticipated