Monetary Policy - A2 Economics

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Monetary Policy

The government can influence the economy through the use of monetary policy. To do this,
they control interest rates, money supply and exchange rates.

How do interest rates affect AD?

1. Housing market
A fall in IR will decrease housing payments/mortgages. This therefore increases
demand for houses, which…

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Thus if the demand for durables fall, the reverse of the above occurs.

How will changes in the IR affect LRAS?


Money consists of coins and bank notes which are issued by the Bank of England, along with
deposits in high street banks and building societies. We are willing…

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Unit of account: In the unit of account, money serves as the common base of
comparison that people use to present prices and record debts. E.g. if a normal TV
cost £100 and a HD TV cost £200, we know what this means and so are able to
compare prices.…

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The demand for money increases, for example, following an increase in income, more
money will be demanded at any given interest rate and the interest rate will increase from IR1
to IR2.

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A fall in the demand for money will lead to a fall in the rate of interest. If the government
increases the money supply, the MS curve will shift to the right from MS1 to MS2. This will
lead to a fall in the IR from IR1 to IR2. A…

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There has been an ongoing discussion amongst economists that the Labour and Tory
government have relied on IR to manipulate AD and that fiscal policy should be used in the
future rather than monetary.

The transmission mechanism of monetary policy

The link between a change in the Bank of England…

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The bank's IR decisions affect interest rates set by mortgage lenders, commercial banks,
and financial institutions. These same decisions and announcements influence the
confidence and expectations or firms and households as well as asset prices and the
exchange rate.

AD is therefore affected ­ the domestic component of demand will…

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fall to 2.5%, and because there are a lot of investors, the price of the bond has risen to £250.
We receive £5.

If a firm can borrow cheaply, it is more likely to invest in machinery/equipment, or to buy
shares in other firms.

Quantitative Easing

Quantitative easing is a…

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also stimulating spending. The positive effects of this may then spread out to the real

The hope is that:

Bank lending starts to flow again, leading to increased household and corporate
Confidence rises as lending and spending increase.
Aggregate demand increases and the economy moves out of recession.…




This is a detailed 8 page summary of monetary policy including diagrams and quantitative easing. Students could use this to help their understanding or produce their own learning resources.

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