Monetary Policy

The use of economic instruments such as:

• Interest Rate
• Exchange Rate
• Supply of money (Quantitative Easing)

in order to achieve macro-economic objectives

Expansionary Monetary Policy

• Fall in normal and real interest rates
• Measures to expand supply of credit -> Loans
• Depreciation of the exchange rate

Expansionary monetary policy shifts AD to the right.

Benefits:

• Grows economy
• Reduces unemployment

Negatives:

• Increases inflation
• Current account position gets worse

Contractionary Monetary Policy

• Higher interest rates on loans and savings
• Tightening of credit supply (loans harder to get)
• Appreciation of the exchange rate

Contractionary monetary policy shifts AD to the left.

Benefits:

• Reduces inflation
• Current account position improves

Negatives:

• Shrinks economy
• Increases unemployment

Money Supply / Quantitative Easing

Quantitative easing involves increasing the money supply.

Originally, to do this, the central bank would just print money, however, this was difficult to control.

Since 2008, there is a new way.

• Central bank creates money
  • Virtually add money to their own account
• Central bank buys bonds
  • Buys from banks such as HSBC, Natwest, Santander
  • These banks have a large influx of cash, making banks more liquid
• Banks have lots of cash, so they lend to make profit through interest
  • Lots of banks compete to lend money
  • Lower interest rate
• Causes businesses and consumers to borrow money
  • Consumer spending and Investment increases
  • Aggregate Demand increases
• Unemployment decreases and Economic growth increases

Drawbacks of Quantitative Easing

• Causes demand-pull inflation
• Worsens the C/A balance deficit
  • More credit means more purchasing of luxury imports
• Asset bubbles
  • Spike in property prices
  • Eventually people realise that it cannot rise anymore
  • Bubble pops, everyone tries to sell
  • Price drops rapidly
• Larger gap between rich and poor

Monetary Policy Committee

The main objective of the monetary policy committee is inflation 2%.

Factors under Consideration

The monetary policy committee's 9 members are presented with lots of information that influences their decision.

• Financial Markets
  • Share prices - Indicating investor confidence
  • Household wealth
  • Consumer confidence
• The International Economy
  • Including the US, Europe and Asia. Trends in ER of £ against $ and €.
• Money and Credit
  • Bank lending and consumer credit figures analysed
• Demand and output
  • Consumption and planned investment survey figures
  • Rate of Real GDP growth
• The Labour Market
  • Figures of unemployment - Indicates demand-pull vs cost-push inflation
• Costs and prices
  • Manufacturer surveys of input costs and factory gate prices used as in indicator of whether firms are passing inflation onto consumers

Problems with accurately forecasting inflation

• CPI has multiple issues
• External shocks can occur at any time
  • Pandemic
  • Russia's invasion of Ukraine

Transmission Mechanism