2_6_2_Monetary_Policy objectives and .pptx

What is monetary
policy?
TUTOR2U.NET/ECONOMICS
MONETARY POLICY

Monetary policy involves changes in interest rates, the supply of
money & credit and exchange rates by the central bank to
influence the macro-economy and achieve target outcomes.
MONETARY POLICY
WHAT IS MONETARY POLICY?

WHAT IS MONETARY POLICY?
• Monetary policy is a macroeconomic tool used by a country's central bank
(such as the Federal Reserve in the United States or the European Central Bank
in the Eurozone or the Bank of England) to manage the money supply and
interest rates to achieve specific economic objectives including price stability.
• Interest Rates: The central bank can set official monetary policy interest rates,
which then affect the interest rates offered by banks to borrowers and savers.
Lowering interest rates can stimulate borrowing and spending, while raising
them can reduce borrowing and spending to control inflation.
• Open Market Operations: Central banks buy or sell government securities in
the open market to influence the money supply. Purchases inject money into
the economy, while sales withdraw money.
MONETARY POLICY

Central Banks
A central bank is the monetary authority and major
regulatory bank in a country. A central bank is responsible
for operating monetary policy and maintaining financial
stability.
Examples of central banks
• Bank of England (UK)
• European Central Bank (ECB) for all member nations of
the Euro Area
• United States Federal Reserve (The Fed)
• Bank of Japan (BOJ)
MONETARY POLICY

OBJECTIVES OF MONETARY POLICY – THE USA
• The United States Federal Reserve (their central bank) has a dual mandate:
• Price Stability: This objective is commonly interpreted as targeting a stable
and moderate rate of inflation. Historically, the Federal Reserve has
targeted an inflation rate of around 2% as being consistent with its price
stability goal.
• Maximum Sustainable Employment: This objective focuses on achieving
the highest level of employment or minimizing unemployment that the
economy can sustain over the long term. The Federal Reserve seeks to
foster conditions that promote job growth and reduce unemployment while
maintaining price stability.
MONETARY POLICY

OBJECTIVES OF MONETARY POLICY – THE UK
• The primary objective of monetary policy in the UK is:
• Price Stability: The main goal of monetary policy in the UK is to maintain
price stability, which is typically interpreted as achieving an inflation rate of
2% as measured by the Consumer Prices Index (CPI).
• Supporting Economic Growth and Employment: While price stability is the
primary goal, the Bank of England is also required to support the economic
policies of the government, including its objectives for growth and
employment. This means that while the primary focus is on controlling
inflation, the Bank of England should also consider the impact of its policies
on the overall economic health of the country.
MONETARY POLICY

Monetary Stability
Monetary stability means a lengthy period of
stable prices and market confidence in the
external value of a currency. Stable prices are
defined by the inflation target, which the Bank
of England seeks to meet through the
decisions taken by the Bank’s Monetary Policy
Committee (MPC).
MONETARY POLICY

Identify different
examples of interest
rates in an economy
MONETARY POLICY

Policy
Interest
Rates
Mortgage
Rates
Savings
Rates
Credit
Card
Rates
Bond
yields
Interbank
Interest
Rates
Bank
Overdraft
Rates
Pay Day
Loan
Rates
MONETARY POLICY
EXAMPLES OF DIFFERENT INTEREST RATES

MONETARY POLICY
CONSUMER CREDIT CARD INTEREST RATES IN THE UK
0%
5%
10%
15%
20%
25%
30%
35%
40%
Q1 2021 Q2 2021 Q3 2021 Q4 2021 Q1 2022 Q2 2022 Q3 2022 Q4 2022
Interest
rate
Personal loan 2,500 U.S. dollars Personal loan 5,000 U.S. dollars Personal loan 10,000 U.S. dollars
Personal loan 25,000 U.S. dollars Credit card* Overdraft

Base Interest Rate (Bank Rate)
The main interest rate set by a nation’s central
bank. This is the rate of interest charged to
commercial banks if they must borrow from
the central bank when short of liquidity.
Market interest rates often take their cue from
changes in the Base Interest Rate.
MONETARY POLICY

Nominal Interest Rate
The nominal rate of interest is known as the
money rate of interest. For example, the
nominal interest rate paid to covers, or the
nominal rate of interest charged on a loan.
MONETARY POLICY

Real Interest Rate
Nominal rate of interest adjusted for inflation.
For example, if the nominal interest rate on a
loan is 5% and the inflation rate is 3%, then
the real interest rate on the loan is +2%.
Real interest rates can be negative if the
nominal interest rate is lower than inflation.
MONETARY POLICY

MORTGAGE INTEREST RATES
Mortgage interest rates are the rates that
lenders charge on a home loan.
They're typically expressed as a percentage
of the loan amount and are paid in addition
to the principal, or the amount borrowed.
Mortgage interest rates are influenced by
several factors, including the general level of
interest rates in the economy, the
creditworthiness of the borrower, and the
loan-to-value ratio (LTV) of the mortgage.
MONETARY POLICY

UK MORTGAGE INTEREST RATES
MONETARY POLICY
0.5%
1.5%
2.5%
3.5%
4.5%
5.5%
6.5%
7.5%
Mar
'00
Dec
'00
Sep
'01
Jun
'02
Mar
'03
Dec
'03
Sep
'04
Jun
'05
Mar
'06
Dec
'06
Sep
'07
Jun
'08
Mar
'09
Dec
'09
Sep
'10
Jun
'11
Mar
'12
Dec
'12
Sep
'13
Jun
'14
Mar
'15
Dec
'15
Sep
'16
Jun
'17
Mar
'18
Dec
'18
Sep
'19
Jun
'20
Mar
'21
Dec
'21
Sep
'22
May
'23
Average
interest
rate
2 year fixed rate mortgages 3 year fixed mortgage 5 year fixed mortgage
10 year fixed 2 year variable

MORTGAGE RATES & EFFECTIVE DISPOSABLE INCOME
MONETARY POLICY
0.5%
1.5%
2.5%
3.5%
4.5%
5.5%
6.5%
7.5%
Mar
'00
Jun
'01
Sep
'02
Dec
'03
Mar
'05
Jun
'06
Sep
'07
Dec
'08
Mar
'10
Jun
'11
Sep
'12
Dec
'13
Mar
'15
Jun
'16
Sep
'17
Dec
'18
Mar
'20
Jun
'21
Sep
'22
Average
interest
rate
2 year fixed rate mortgages 3 year fixed mortgage
5 year fixed mortgage 10 year fixed
2 year variable
A rise in mortgage interest rates means
that many home-owners with a
mortgage must pay more each month to
service their debt.
This will lead to a drop in their effective
disposable income, meaning that they
have less money to spend on other
goods and services.
As a result, more expensive mortgages
can cause a slowdown in the growth of
or even a drop in aggregate demand.

How do changes in
monetary policy interest
rates affect the macro-
economy?
MONETARY POLICY

UK BANK BASE RATE AND CPI INFLATION
MONETARY POLICY
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
Jan
2018
Mar
2018
May
2018
Jul
2018
Sep
2018
Nov
2018
Jan
2019
Mar
2019
May
2019
Jul
2019
Sep
2019
Nov
2019
Jan
2020
Mar
2020
May
2020
Jul
2020
Sep
2020
Nov
2020
Jan
2021
Mar
2021
May
2021
Jul
2021
Sep
2021
Nov
2021
Jan
2022
Mar
2022
May
2022
Jul
2022
Sep
2022
Nov
2022
Jan
2023
Mar
2023
May
2023
Central bank interest rate Inflation rate

INFLATION AND POLICY INTEREST RATES BY COUNTRY
MONETARY POLICY
Interest rate
Jan 2022
inflation
June 2023
inflation
Jan 2022 central
bank interest rate
June 2023 central
bank interest rate
Australia 3.5% 6% 0.1% 4.1%
Brazil 10.4% 3.2% 9.2% 13.75%
Canada 5.1% 2.8% 0.5% 4.75%
China 0.9% 0% 3.7% 3.55%
Euro Area 5.1% 5.5% 0% 4%
India 6% 4.81% 4% 6.5%
Japan 0.5% 3.3% -0.1% -0.1%
Sweden 3.9% 9.3% 0% 3.5%
United Kingdom 5.5% 7.9% 0.25% 5%
United States 7.5% 3% 0.08% 5.13%

INFLATION AND POLICY INTEREST RATES IN THE USA
MONETARY POLICY
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
Jan
2018
Mar
2018
May
2018
Jul
2018
Sep
2018
Nov
2018
Jan
2019
Mar
2019
May
2019
Jul
2019
Sep
2019
Nov
2019
Jan
2020
Mar
2020
May
2020
Jul
2020
Sep
2020
Nov
2020
Jan
2021
Mar
2021
May
2021
Jul
2021
Sep
2021
Nov
2021
Jan
2022
Mar
2022
May
2022
Jul
2022
Sep
2022
Nov
2022
Jan
2023
Mar
2023
May
2023
Federal Reserve interest rate Inflation rate

FACTORS CONSIDERED WHEN SETTING BANK RATE
• Rate of growth of real GDP and the estimated size of the output gap
• Forecasts for price inflation
• Rate of growth of wages and other business costs
• Movements in a country’s exchange rate
• Rate of growth of asset prices such as house prices
• Movements in consumer and business confidence
• External factors such as global energy prices and inflation in other countries
• Financial market conditions including the rate of growth of credit / money
MONETARY POLICY

HOW HIGHER INTEREST RATES CONTROL INFLATION
• Higher interest rates raise the cost of borrowing for businesses and consumers,
which slows consumer spending and business investment.
• This reduces aggregate demand for goods and services, which in turn eases
upward pressure on retail prices.
• Higher interest rates lead to an appreciation of the currency. This makes
imports cheaper which then helps to reduce inflation.
• Higher interest rates increase the return on savings, which encourages saving
and helps to reduce inflationary pressures from excess aggregate demand.
• Central banks might also think that an increase in the cost of borrowing sends
a message to businesses and unions when negotiating pay settlements.
MONETARY POLICY

UK MONETARY POLICY IN COST-OF-LIVING CRISIS
The UK has been going through a cost-of-living
crisis, with rising inflation and interest rates.
This has put a strain on households, as the cost of
necessities like food and energy has increased.
To try to combat inflation, the Bank of England
has been raising interest rates.
This has made borrowing more expensive and
has increased the cost of mortgages for many
people.
The result has been a squeeze on household
budgets, with many people struggling to make
ends meet.
MONETARY POLICY
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
Jan
2018
Jun
2018
Nov
2018
Apr
2019
Sep
2019
Feb
2020
Jul
2020
Dec
2020
May
2021
Oct
2021
Mar
2022
Aug
2022
Jan
2023
Jun
2023

Expansionary Monetary Policy
Cuts in interest rates or an increased supply of
credit designed to increase AD.
MONETARY POLICY

Bank cuts their main
interest rate
• Expansionary
policy
• Designed to
stimulate
aggregate demand
Sends a signal to
financial markets
• Commercial banks
• Other lenders
including
mortgage lenders
Possible change in
market interest rates
• Credit card rates
• Overdrafts
• Loans
• Savings rates
• Mortgage rates
MONETARY POLICY
INTEREST RATE TRANSMISSION MECHANISM

MONETARY POLICY
INTEREST RATE TRANSMISSION MECHANISM
Bank cuts their
main interest rate
Sends a signal to
financial markets
Possible change in
market interest
rates
Change in
components of
aggregate demand
Change in demand-
pull inflationary
pressure (output
gap)
Change in the rate
of inflation

How might a fall in a
country’s interest rates
have an impact on the
exchange rate?
MONETARY POLICY

Central bank cuts
policy (base) rate of
interest
Commercial banks
cut their interest
rates including on
savings
Rate of return on
savings decreases
in UK
Investors might
move some of their
savings out of UK
banks
Outflow of "hot
money" from the
UK
Assume it flows
into Switzerland
(i.e. into their
commercial banks)
Investors will be
selling sterling and
buying Swiss francs
Ceteris paribus,
sterling will
depreciate against
the Swiss franc
MONETARY POLICY
LOWER INTEREST RATES AND THE EXCHANGE RATE

Negative interest rates
When a nation’s central bank charges commercial
banks interest for holding funds with them. This
policy would be designed to get commercial banks to
lend out to people and businesses rather than hold
money on account at the central bank. In an extreme
form, savers might be charged interest on their
savings.
MONETARY POLICY

Deflationary Monetary Policy
A deflationary monetary policy is an approach
taken by a central bank to reduce the money
supply or raise interest rates with the primary
goal of decreasing aggregate demand and
slowing down economic activity. The aim of a
deflationary monetary policy is to combat
inflation and maintain price stability.
MONETARY POLICY

DEFLATIONARY MONETARY POLICIES IN RECENT YEARS
MONETARY POLICY
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
Sep
'19
Nov
'19
Jan
'20
Mar
'20
May
'20
Jul
'20
Sep
'20
Nov
'20
Jan
'21
Mar
'21
May
'21
Jul
'21
Sep
'21
Nov
'21
Jan
'22
Mar
'22
May
'22
Jul
'22
Sep
'22
Nov
'22
Jan
'23
Mar
'23
May
'23
Central
bank
interest
rate
Brazil China Euro area India Japan United Kingdom United States

1. Consumer Spending: Higher interest rates make it more expensive for households to
service their debts, reducing effective disposable income.
2. Household Saving: The return on saving usually rises – leading to an increase in the
propensity to save and a fall in consumer demand
3. Investment: Higher interest rates make borrowing more expensive for firms, which can
reduce their investment in new capital
4. Exchange Rates: A rise in interest rates can lead to an appreciation of the domestic
currency, making exports more expensive and imports cheaper. This can lead to a
decrease in aggregate demand as firms and consumers reduce spending on foreign
goods.
5. Asset Prices: Higher interest rates can also reduce the value of assets such as stocks,
bonds, and housing, leading to a decrease in aggregate demand as households reduce
spending in response to lower wealth.
ECONOMIC EFFECTS OF HIGHER INTEREST RATES
MONETARY POLICY

How can we show the
effects of higher interest
rates using AD-AS
analysis diagrams?
MONETARY POLICY

General price level (GPL)
Real National Income (Y)
Aggregate Demand (AD)
Short Run Aggregate Supply (SRAS)
Y1
GPL1
Long Run Aggregate Supply (LRAS)
YP Y2
The aim of a
deflationary monetary
policy is to lower
aggregate demand and
help close a positive
output gap
AD2 (with a
Credit Boom)
MONETARY POLICY
GPL2

Y1
GPL1
YP Y2
The aim of a
deflationary monetary
policy is to lower
aggregate demand and
help close a positive
output gap
AD2 (with a
Credit Boom)
MONETARY POLICY
AD3
AD3
GPL2
GPL3

Y1
GPL1
YP Y2
If rising interest rates
cause a currency
appreciation, this can
lead to lower import
prices which causes an
outward shift of short-
run aggregate supply.
AD2 (with a
Credit Boom)
MONETARY POLICY
AD3
AD3
SRAS2 with a currency
appreciation
GPL2
GPL3
GPL4

GIVE ME 3…
Effects of the sustained rise in
monetary policy interest rates
by the Bank of England
MONETARY POLICY

GIVE ME 3…
Effects of the rise in interest rates by the Bank of England
1
2
3
Slowdown in the housing market – risk of drop in house
prices and contraction in construction output & jobs
Rise in corporate debt repayments – many businesses
borrowed heavily during the pandemic – rise of jump in
business failures with consequences for unemployment
Increase in borrowing costs might cause a fall in planned
capital investment by firms which has consequences for long
run aggregate supply as well as AD
MONETARY POLICY

EFFECTS OF HIGHER INTEREST RATES ON BUSINESSES
• Firstly, they increase the cost of borrowing, which can make it more expensive
for businesses to invest in new equipment or expand their operations.
• Secondly, they can lead to a decrease in consumer spending, as higher interest
rates tend to reduce people’s effective disposable income and make them less
likely to spend on non-essential items.
• Thirdly, higher interest rates can make it more expensive for businesses to
refinance existing debt. They can increase the cost of working capital, which
can put pressure on a business's cash flow and profitability.
• If higher interest rates lead to a currency appreciation, then exporters may find
that they become less price competitive in overseas markets.
MONETARY POLICY

EFFECTS OF HIGHER INTEREST RATES ON HOUSEHOLDS
• Firstly, they can make borrowing more expensive. This can impact consumers
looking to take out a loan or credit card, as well as those with existing variable-
rate debts like mortgages or car loans.
• Secondly, higher interest rates can lead to lower levels of consumer spending,
as consumers may tighten their belts and focus on paying down their debts.
• Higher rates can also lead to a worsening of consumer confidence (or animal
spirits) especially if people fear that they might lead to a recession.
• Increase mortgage rates might cause a drop in average house prices.
• Higher interest rates can have an impact on the value of people's savings, as
interest rates on savings accounts increase – good news for savers!
MONETARY POLICY

GIVE ME 3…
Reasons why higher interest
rates … in theory … will lead to
disinflation in the UK economy
MONETARY POLICY

GIVE ME 3…
Reasons why higher interest rates will cut inflation
1
2
3
Appreciation of the exchange rate via an inflow of hot
money – makes imports cheaper (direct impact on CPI)
Slower growth of aggregate demand helps eliminate a
positive output gap – less demand-pull inflation
Wage inflation - Reduced consumer borrowing and
spending may cause the labour market to soften – fall in
job vacancies / perhaps leading to weaker wage growth
MONETARY POLICY

GIVE ME 3…
Reasons why the BoE’s rate
rises might in practice have
little direct impact on inflation
MONETARY POLICY

GIVE ME 3…
Why higher interest rates have a limited impact on prices
1
2
3
Most of the surge in inflation has come from external
shocks over which the central bank has no direct control
It takes time for higher interest rates to affect inflation –
time lags in monetary policy transmission mechanism
Rising cost of servicing debt might cause some
businesses with cash-flow problems to cut output –
making supply shortages worse leading to rising prices
MONETARY POLICY

How might higher
interest rates affect
aggregate supply?
MONETARY POLICY

• When interest rates rise, it becomes more expensive for firms to borrow
money for capital investment, causing a decrease in investment and
hence a possible decrease in long run aggregate supply.
• A drop in investment means that an economy’s capital stock will age
possibly leading to a fall in productivity / efficiency
• Higher interest rates can reduce the profitability of businesses
(borrowing costs are increased and consumer demand contracts). If
profits decline, then businesses may have less to spend on research and
development and innovation which might then lead to lower labour
productivity.
How can higher interest rates affect aggregate supply?
MONETARY POLICY

1. Higher interest rates usually cause an appreciation of the exchange rate. This
can allow domestic businesses to buy imported capital equipment / software
and hardware at a lower price. This might cause capital spending to rise.
2. Higher interest rates are designed by a central bank to help control inflation.
If this policy is successful, then lower inflation will help to improve
macroeconomic stability and business confidence. This in turn can help
promote investment demand.
3. Higher interest rates can encourage households to save more money, which
can increase the pool of funds available for lending to businesses, potentially
making it easier and cheaper for them to access financing.
Evaluation – benefits of higher interest rates on LRAS
MONETARY POLICY

NEGATIVE INTEREST RATES IN JAPAN
• Japan has been dealing with a prolonged period of low inflation (including
periods of price deflation) and low economic growth.
• To stimulate the economy and boost inflation, the Bank of Japan has used
negative interest rates as one of its policy tools.
• Essentially, this means that commercial banks must pay a fee to keep their
reserves at the Bank of Japan, rather than earning interest on them.
• This is designed to incentivize banks to lend money and invest in the economy,
rather than just keeping their money parked at the central bank.
• Negative interest rates might also lead a currency depreciation which can
increase the price of imports and make Japanese exports more competitive.
MONETARY POLICY

NEGATIVE INTEREST RATES IN JAPAN
MONETARY POLICY
-0.1%
-0.1%
-0.1%
-0.1%
0.0%
0.0%
0.0%
Sep
'16
Dec
'16
Mar
'17
Jun
'17
Sep
'17
Dec
'17
Mar
'18
Jun
'18
Sep
'18
Dec
'18
Mar
'19
Jun
'19
Sep
'19
Dec
'19
Mar
'20
Jun
'20
Sep
'20
Dec
'20
Mar
'21
Jun
'21
Sep
'21
Dec
'21
Mar
'22
Jun
'22
Sep
'22
Dec
'22
Mar
'23
Jun
'23
Interest
rate
in
pecent
per
year

NEGATIVE INTEREST RATES TO TACKLE DEFLATION
MONETARY POLICY
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
2016
2019
2022
2025*
2028*
Inflation
rate
compared
to
previous
year
The Japanese economy has been
dealing with the risk of deflation
for many years now. Deflation is a
dangerous economic situation in
which prices fall across the board,
leading consumers to delay their
spending in anticipation of even
lower prices. This can lead to a
vicious cycle of low economic
growth. By implementing negative
interest rates, the Bank of Japan
hopes to encourage spending and
investment and to push inflation
back into positive territory.

1 What is the primary goal of monetary policy?
A Maximizing government revenue
B Achieving full employment
C Encouraging international trade
D Controlling inflation and maintaining price stability
MONETARY POLICY

2
An economy has a positive output gap, and the central bank decides to
increase interest rates. Which one of the following outcomes is most likely to
result from the higher interest rates?
MONETARY POLICY
Investmen
t
Output
gap
Savings
A Decrease Decrease Increase
B Decrease Increase Decrease
C Increase Decrease Decrease
D Increase Increase Increase

3
A government wanting to use monetary policy to reduce deflation could
decrease the
A Exchange rate
B Money supply
C Minimum wage
D Rate of indirect tax
MONETARY POLICY

4 The Bank of England’s Monetary Policy Committee increases Bank Rate to reduce the risk
of an increase in inflationary pressure in the economy. All other things being equal, which
one of the following is most likely to result from the policy change?
A Consumption will increase since house prices will rise and increase wealth.
B
An increase in the government’s target for the rate of inflation following a
significant increase in the rate of productivity growth
C An increase in the savings ratio as the economy recovers from a recession
D
A rise in share prices on global stock markets due to the growth in world
trade
MONETARY POLICY

4 The Bank of England’s Monetary Policy Committee increases Bank Rate to reduce the risk
of an increase in inflationary pressure in the economy. All other things being equal, which
one of the following is most likely to result from the policy change?
A Consumption will increase since house prices will rise and increase wealth.
B
An increase in the government’s target for the rate of inflation following a
significant increase in the rate of productivity growth
C
An increase in the savings ratio as the economy recovers from a
recession
D
A rise in share prices on global stock markets due to the growth in world
trade
MONETARY POLICY

5 Many firms use profits to finance their capital investment instead of borrowing from banks.
For these firms, higher interest rates are most likely to
A
cause them to reduce their investment as they can now earn more interest
from saving their profits.
B
cause them to change the type of investment made with more investment
in buildings.
C
have no impact on the amount of investment undertaken as they pay no
interest
D
result in more investment as they can earn more interest on money
deposited in banks.
MONETARY POLICY

5 Many firms use profits to finance their capital investment instead of borrowing from banks.
For these firms, higher interest rates are most likely to
A
cause them to reduce their investment as they can now earn more
interest from saving their profits.
B
cause them to change the type of investment made with more investment
in buildings.
C
have no impact on the amount of investment undertaken as they pay no
interest
D
result in more investment as they can earn more interest on money
deposited in banks.
MONETARY POLICY

6 The Monetary Policy Committee of the Bank of England has to assess inflationary
pressures when deciding on the level of Bank Rate. Which one of the following pieces of
information is most likely to persuade the Committee to raise Bank Rate?
A A fall in the number of job vacancies advertised
B GDP growth at below the trend rate in the previous two quarters
C Surveys showing that many firms have spare capacity
D Statistics showing an increase in bank lending to households
MONETARY POLICY

7 When the Bank of England raises interest rates, how does it typically impact
the UK housing market?
A It encourages higher home prices and increased demand for housing
B
It discourages borrowing and may lead to a decrease in home sales and
prices.
C It has no significant effect on the housing market.
D It only affects the rental market, not the sale of homes.
MONETARY POLICY

7 When the Bank of England raises interest rates, how does it typically impact
the UK housing market?
A It encourages higher home prices and increased demand for housing
B
It discourages borrowing and may lead to a decrease in home sales
and prices.
C It has no significant effect on the housing market.
D It only affects the rental market, not the sale of homes.
MONETARY POLICY

8 In response to rising interest rates, what is one strategy that homeowners in
the UK may consider to mitigate the impact on their mortgage payments?
A Refinancing their mortgages to lock in lower rates.
B Increasing their home's selling price.
C Taking on additional consumer debt to cover mortgage costs.
D Reducing the size of their mortgage down payment (deposit)
MONETARY POLICY

9 Which one of the following is a correct statement about monetary policy in
the UK?
A Monetary policy does not affect the supply side of the economy
B
When the government uses contractionary fiscal policy, the Bank of
England will use expansionary monetary policy to offset the effects
C
Lower interest rates may reduce deflationary pressure but they may also
reduce savings
D
Monetary policy may involve the expansion of the money supply to reduce
aggregate demand
MONETARY POLICY

9 Which one of the following is a correct statement about monetary policy in
the UK?
A Monetary policy does not affect the supply side of the economy
B
When the government uses contractionary fiscal policy, the Bank of
England will use expansionary monetary policy to offset the effects
C
Lower interest rates may reduce deflationary pressure but they may
also reduce savings
D
Monetary policy may involve the expansion of the money supply to reduce
aggregate demand
MONETARY POLICY

10 Which one of the following combinations is correct regarding the rate of
inflation and the responsibilities of the UK Government and Monetary Policy
Committee (MPC) of the Bank of England?
MONETARY POLICY
Inflation target set
by
Interest rate set
by
A Government Government
B Government MPC
C MPC MPC
D MPC Government

Quantitative Easing
A central bank uses quantitative easing (QE) to
increase the supply of money in the banking system
designed to encourage commercial banks to lend at
cheaper interest rates to small & medium sized
businesses. It is a form of expansionary monetary
policy and has been used as a technique to stimulate
aggregate demand at a time when nominal interest
rates have fallen to historically low levels.
QUANTITATIVE EASING

WHAT IS QUANTITATIVE EASING?
• Quantitative easing (QE) is a monetary policy tool used by central banks to
stimulate the economy.
• The basic idea is that when the economy is sluggish, the central bank buys
assets like government bonds from commercial banks and other financial
institutions. The banks get cash in return for selling bonds.
• This increases the amount of money in the financial system and, in theory,
encourages banks to lend more and consumers and businesses to spend more.
• QE is a way of injecting money into the economy to stimulate growth.
• It has been used by many central banks around the world, including the US
Federal Reserve, the Bank of England, and the European Central Bank.
QUANTITATIVE EASING

HOW DOES QUANTITATIVE EASING WORK?
• Central bank (such as the Bank of England) creates new money electronically to make
large purchases of assets (bonds) from the private sector
• Commercial banks then receive cash from BoE asset purchases, and this increases
their liquidity and might encourage them to lend out to customers which will help to
stimulate an increase in loan-financed capital investment
• Increased demand for government bonds increases the market price of bonds. Higher
bond price causes a fall in the yield on a bond (this is because there is an inverse
relationship between bond prices and yields). Lower bond yields / long term interest
rates may cause the currency to depreciate
• Those who have sold bonds may use the extra cash to buy assets with relatively higher
yields such as shares of listed businesses and corporate bonds
QUANTITATIVE EASING

BROAD MONEY SUPPLY IN THE UK ECONOMY
QUANTITATIVE EASING
1,950
2,150
2,350
2,550
2,750
2,950
3,150
Jan
2010
May
2010
Sep
2010
Jan
2011
May
2011
Sep
2011
Jan
2012
May
2012
Sep
2012
Jan
2013
May
2013
Sep
2013
Jan
2014
May
2014
Sep
2014
Jan
2015
May
2015
Sep
2015
Jan
2016
May
2016
Sep
2016
Jan
2017
May
2017
Sep
2017
Jan
2018
May
2018
Sep
2018
Jan
2019
May
2019
Sep
2019
Jan
2020
May
2020
Sep
2020
Jan
2021
May
2021
Sep
2021
Money
supply
amounts
outstanding
in
billion
£S
Money supply is understood as the
entire stock of currency and other
liquid financial instruments
circulating in the economy of the
country at the point in time. In the
United Kingdom, this measure
includes currency (notes and coin),
and funds in commercial bank
accounts. Banks create deposits
when they lend out to businesses
and households. QE has
contributed to a significant
increase in the UK’s money supply.

HOW CAN A CENTRAL BANK REDUCE MONEY SUPPLY?
• One way is by raising interest rates. This makes it more expensive for banks to
borrow money from the central bank, and in turn, they raise the interest rates
that they charge their customers. This makes it more expensive to borrow
money, so people and businesses are less likely to do so. A lower demand for
credit means that less new money is created by the banking system
• Another way is by the central bank selling government bonds through their
open market operations. This reduces the amount of money that commercial
banks have available to lend out.
• Finally, the central bank can require banks to hold more cash in reserve, which
also reduces the amount of money they have available to lend out.
QUANTITATIVE EASING

WHAT ARE BANK RESERVE REQUIREMENTS?
• Commercial bank reserve requirements are rules set by the central bank that
require banks to hold a certain percentage of their deposits in reserve.
• The reserve requirement is the minimum amount of funds that banks must
keep on hand as cash or in deposits at the central bank.
• This ensures that banks have enough money to meet the demands of their
customers and helps to prevent bank runs.
• Reserve requirements can also be used as a tool to control the money supply.
• When the reserve requirement is increased, banks have less money available
to lend out, which slows down the economy.
QUANTITATIVE EASING

DOES THE UK HAVE A BANK RESERVE REQUIREMENTS
• The United Kingdom does not currently have commercial bank reserve
requirements.
• In the UK, banks are required to meet a "liquidity coverage ratio," which is a
measure of how well a bank can withstand a short-term disruption to its ability
to meet its financial obligations.
• This is like a reserve requirement in that it sets a minimum level of funds that a
bank must have on hand, but it is calculated differently and is based on a
longer time frame.
• The liquidity coverage ratio was introduced in the UK in 2015 as part of a
package of measures to strengthen the resilience of the banking system.
QUANTITATIVE EASING

WHAT IS QUANTITATIVE TIGHTENING?
• Quantitative tightening (QT) is the opposite of quantitative easing (QE).
• While QE increases the money supply by creating new money and using it to
purchase government bonds, QT decreases the money supply by the central
bank going into financial markets and selling government bonds.
• The goal of QT is to reduce the amount of money in circulation and to increase
market interest rates.
• This can help to slow down inflation and to correct imbalances in the economy,
such as an overheated housing market. QT can also reduce the amount of
credit available in the economy and can lead to a contraction in economic
activity.
QUANTITATIVE EASING

GIVE ME TWO
Two roles of the Central Bank in the
United Kingdom
QUANTITATIVE EASING

GIVE ME 2…
Two roles of the Central Bank in the United Kingdom
1
2
Operation of monetary policy – setting base interest
rates to meet the inflation target (2%). No direct
intervention in the exchange rate – the UK operates a
free floating currency
Lender of last resort to the financial system during a
liquidity crisis / credit crunch.
QUANTITATIVE EASING

GIVE ME TWO
Two possible consequences for
financial markets of a large increase in
the size of quantitative easing (QE) by
the UK central bank.
QUANTITATIVE EASING

GIVE ME 2…
Two possible consequences for financial markets of a large increase
in the size of quantitative easing (QE) by the UK central bank.
1
2
Lower interest rates: By purchasing large amounts of government
bonds, the central bank increases demand for these assets, which
pushes up their prices and reduces their yields. This can lead to a
fall in mortgage interest rates and corporate bond interest rates
Currency depreciation: Another effect of a large increase in QE by
the UK central bank might be a depreciation of the currency. QE
increases the money supply and some of this extra liquidity will
leave the UK economy – sterling is sold – causing the pound to fall
QUANTITATIVE EASING

1 Quantitative easing (QE) is a monetary policy tool that involves:
A Reducing interest rates to stimulate borrowing
B Increasing the money supply by purchasing financial assets
C Raising reserve requirements for commercial banks
D Controlling exchange rates through currency interventions
QUANTITATIVE EASING

2
Which of the following assets is typically purchased by a central bank during
a quantitative easing programme?
A Corporate stocks
B Real estate properties
C Foreign currencies
D Government bonds and securities
QUANTITATIVE EASING

3
What is one potential side effect of an extended period of quantitative easing
(QE)?
A Higher long-term interest rates
B Reduced money supply and deflation
C Asset price bubbles and financial market distortions
D Increased exchange rates and stronger currency
QUANTITATIVE EASING

4
What is the general aim of quantitative easing in times of economic crisis or
recession?
A
To support economic recovery by providing liquidity and lowering borrowing
costs
B To encourage higher interest rates and boost savings
C To reduce government spending and fiscal deficits
D To create deflationary pressures and reduce consumer spending
QUANTITATIVE EASING

4
What is the general aim of quantitative easing in times of economic crisis or
recession?
A
To support economic recovery by providing liquidity and lowering
borrowing costs
B To encourage higher interest rates and boost savings
C To reduce government spending and fiscal deficits
D To create deflationary pressures and reduce consumer spending
QUANTITATIVE EASING

5
Why might quantitative easing (QE) lead to a depreciation of a country's
currency?
A QE increases interest rates, attracting foreign capital.
B QE reduces the money supply, making the currency more valuable.
C QE raises inflation, making the currency less attractive.
D
QE increases the money supply, lowering interest rates and reducing the
currency's value.
QUANTITATIVE EASING

5
Why might quantitative easing (QE) lead to a depreciation of a country's
currency?
A QE increases interest rates, attracting foreign capital.
B QE reduces the money supply, making the currency more valuable.
C QE raises inflation, making the currency less attractive.
D
QE increases the money supply, lowering interest rates and reducing
the currency's value.
QUANTITATIVE EASING

6
In recent years, several central banks around the world have implemented a
policy of quantitative easing (QE). All other things being equal, which one of the
following combinations A, B, C or D, is most likely to be the result of this policy?
QUANTITATIVE EASING
Bank
liquidity
Bond prices
Long-term
interest rates
A Decrease Fall Rise
B Increase Fall Rise
C Decrease Rise Fall
D Increase Rise Fall

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