Note on Monetary policy

Monetary Policy

• Monetary policy influences on decisions we make about how much we save, borrow and spend.
• Decision made by the Central Banks have impact on consumers and businesses
  

4 Functions of money

1. Medium of exchange- used for payment for goods
2. Unit of account- used to relative measure prices and draw up accounts
3. Standard of differed payment- Using credit
4. Store Value- If general price is high, then the currency is low
   

• If Bank of England lower the rate of interests, then banks cut on their overdrafts and loans
• Real Rate of return on savings= Nominal rate of interest- the rate of inflation
• Bank-> Decide Monetary policy (MPC)
• MPC- Monetary Policy Committee
  
• MPC= 9 members, some are from government and the others are from bank of England
  
  

Job of Monetary Policy Committee

1. Make appropriate interest rates with need to meet an " Inflation Target" set by government.
   

• Inflation Target= Consumer price inflation of 2%
• Inflation Target can vary by 1% either side- little leeway

Interest Rates-> Financial Markets-> AD and output-> Final effect on CPI inflation

• It takes about 6~12 months to get on to AD and output from change in interest rates
  
• It takes about 12~24 months to have final effect of CPI inflation from change in interest rates

• Singles rate changes rarely happen in isolation!
• Transmission Mechanism of Monetary policy- Several ways in which changes interest rates influence AD

Click the image. Important summary.

• If the `Trade Deficit` widens-> withdrawal of demand and also it reduce excess demand in the economy.
• Interest elastic demand-> Markets most affected by interest rates-> Demand responds elastically to a change in interest rates.
  EX) Those directly linked to demand conditions in housing market, exporters of manufactured goods, the construction industry and leisure services.
• Bank of England-> interest rates
• MPC-> consumer and business behavior
• Large and small businesses-> Price
  

Difficulties in making interest rates

1. Credit crunch
2. Recession in housing
3. Depreciation of the pound against EURO
4. Strong inflationary pressures from the economy