Monetary Policy

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What is monetary policy?

  • Use of interest rate, quantitative easing and controls over bank lending by the monetary policy comittee to control inflation
  • By raising or lowering its own interest rate, 'bank rate' the bank of england hopes to influence the interest rates made by commercial banks and there by to manage the level of AD and control inflation (target 2.0)
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How monetary policy affects the price level and re

  • Monetary policy affects the other components of AD like C, I and (x-m)
  • When people are encourages to save --> less income available for consumption --> consumption decreases --> AD decreases
  • High interest rates --> causes business rates to postpone/cancel investment b/c of higher cost of borrowing --> investment decreases --> AD decreases
  • High interest rates attract capital flows to the UK --> £ exchange rate rises --> UK exports less price competitive --> current account worsens --> AD decreases
  • Cuts in interest rates also has the opposite effect in each of these scenarios
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