Monetary Policy

Eddie, Raymond EBS 1

Contents

What is monetary policy? Monetary Policy Committee (MPC) Basis of Monetary Policy Classical Q antity !heory of Money !he "nterest Rate !ransmission Mechanism #ifferent type of monetary policies Reference

What is monetary policy?

Macroeconomic policies !he amo nt of money in circ lation !he price of money Short$term interest rates %ey area$"nterest rates

Monetary Policy Committee (MPC)

Ban& of En'land Set p short$term interest rates ( day each month )official rate*

+fficial Rate

Basis of Monetary Policy

,on' r n relationship Money - "nflation #emand for money $Md S pply of money $Ms

Classical Q antity !heory of Money

M. / PQ (0here M / the money stoc&, . / -elocity of circ lation, P / price le-el and Q / le-el of real o tp t) P 1 Q / 2 (3ominal income4o tp t) 5orm la can also 6e 0ritten as7 M. / 2

Classical Q antity !heory of Money

8ss med . and 2 0ill hold constant in the lon' term9 . (or :.) tend to fi1ed and sta6le the Q (; :Q), in the lon'$r n e< ili6ri m 0ill ha-e sa me real income4o tp t9 (or 0e ass med that there hae f ll employment in the economy) So, 0hen M is chan'ed, P 0ill chan'e9 Ms=> P=

Money

Supply of Money: Narrow Money ? notes and coins in circ lation (M@) Broad Money ? 3otes and coins pl s money h eld in 6an& and 6 ildin' society acco nts (MA) 8 rise in either (ceteris pari6 s) mi'ht si'nal a ris e in a''re'ate demand (8#)

!he "nterest Rate !ransmission Mech anism

!he process 6y 0hich a chan'e in interest r

ates feeds thro 'h to 8#

!he "nterest Rate !ransmission Mec hanism 1

Credit Individuals Loans Interest Rates Borrowing Firms Existing Loans New Loans Investment Consumption

Margins

Costs

Employment

Consumption

!he "nterest Rate !ransmission Mechanism (

Disposable Income

Existing roperty E!uity Demand "or New #ousing Consumption

Consumption

Interest Rates

Mortgages New

Investment

$avings

!he "nterest Rate !ransmission Mechanism B

Mp
&ppreciation

Dm

'p
Interest Rates Exc%ange Rates

Dx Balance of Payments

Mp
Depreciation

Dm

'p

Dx

#ifferent type of monetary policies

E1pansionary Contractionary

E1pansionary monetary policies

Ms=or "nterest rate C C =, " =, D =or 3E => 8#=

Contractionary monetary policies

MsCor "nterest rate = C C, " C, D Cor 3E C> 8#C

Reference

Bank of England, (2012), http744 00096an&ofen'land9co9 &4Pa'es4home9asp1 SY Econ, (2012), http7440009sy$econ9or' Bi ed, (2012), http74400096iFed9co9 &4

!ue"#ion #i$e

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