2.5++++Monetary+policy

Monetary Policy

[|Student copy of notes on Monetary Policies]

Look at this Prezi presentation and watch the embedded video. Work at your own pace, and review each point again if you are uncertain of anything. Make brief rough notes as you go along, outlining the key points. Then check below that you really understand Monetary policy

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You can see the definition and explanation of monetary policy below, but before we go any further watch this very short video on monetary policy in China in January 2011. What are the different policy tools mentioned and what are they trying to achieve? media type="file" key="Monetary policy in China 2011.mp4" width="300" height="300"

=Monetary Policy =

 Attempts to control the money supply or the rate of interest are examples of monetary policy. The most commonly used examples of monetary policy are: · Interest Rate Control · Direct Controls

Interest Rates
Interest rates measure the rate of return on savings and the cost of borrowed money There is no unique rate of interest - but they all tend to move in the same direction The real rate of interest is the money rate of interest adjusted for inflation Changes in rates have big effects on the economy and individual markets and industries

How do Central Banks Set Interest Rates: media type="youtube" key="HxThJqADl54" width="560" height="315" The main interest rates in the economy are

· Base interest rates (often set by the Central Bank) <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">· Interbank lending rates <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">· Interest rate on Govt bonds <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">· Mortgage Interest Rates for home owners (options include variable and fixed rate loans) <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">· Savings Rates on specific Bank Accounts <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">· The real rate of interest (the rate of interest adjusted for the rate of inflation)

[]  <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">A change in interest rates has wide-ranging effects on the economy. Some of these “transmission mechanisms” are explained below. In each case we consider a cut in rates.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Housing market & house prices (wealth effects)

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">High interest rates increase the cost of mortgages and reduce the demand for most types of housing. A fall in interest rates should stimulate higher demand and prices. This should increase consumption associated with house buying and the rise in prices will increase total housing wealth and make consumers more confident about their personal finances

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Effective disposable incomes of mortgage payers

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">If interest rates fall, the income of homeowners who have variable-rate mortgages with their building society or bank will increase – leading to a rise in their effective purchasing power

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Credit demand

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Low interest rates encourage people to spend using credit and should boost demand for "big ticket" consumer durables and high street spending generally

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Investment & Stock building

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Firms take interest rates into account when deciding whether to proceed with investment spending. A fall in rates should increase business confidence and raise planned fixed investment

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Exchange Rates

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Lower rates might lead to a depreciation of the currency. If interest rates in China fall, then less people will bring money into China, to save in Chinese banks. This will lead to a fall in demand for RMB and so a depreciation in the currency. This will make imports more expensive and possibly lead to inflationary pressures.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">The opposite occurs if interest rates are high. The RMB appreciates and so import prices are low and inflation is controlled.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">A Redistribution of Income for Savers & Borrowers

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">When interest rates fall, there is a re-distribution of income away from lenders towards those with variable rate loans. People with net savings also stand to lose out from big cuts in interest rates.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Evaluation: Remember that although a change in interest rates affects the economy in many ways there are inevitable time lags involved. It is also worth stressing that some industries are more affected by interest rate changes than others (for example exporters) and some regions of the economy are also more exposed (sensitive) to a change in the direction of interest rates. The impact of interest rate movements is not uniform throughout the economy.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Why might interest rate cuts alone, not stimulate AD enough to promote economic growth.

=<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Direct Controls =

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">These are specific controls directed at banks with the aim of restricting their ability to lend. An example is forcing banks to hold a higher proportion of deposits in cash reduces their ability to increase lending. <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Special Deposits are another important example - banks failing to obey instructions from the Central Bank to restrict lending could have liquid assets confiscated and placed on deposit at the Bank. <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Controls like these were have generally been abandoned because it was felt that they merely deflected lending away from banks (who were controlled), but that the lending continued from other sources. This can be moneylenders or overseas banks.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Extension Work

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Quantitative Easing: (not part of the syllabus- but interesting!) <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Basically this is where Governments print money, so increasing the supply of money and so increase Aggregate Demand. This is also regarded as Monetary Policy. It is being used in 2009 to inject cash into the commercial banks, so they can lend more (and also improve their own balance sheets, so they have enough liquid assets on their books). It works like this. Gov. prints money and uses this money to buy commercial banks non liquid assts. The commercial banks now have more cash than they need so increase borrowing.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Here is a short presentation on QE media type="youtube" key="io16sKUHjvw" width="420" height="315"

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Money (BBC Podcast) <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">media type="custom" key="13811204" <span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">rss url="http://downloads.bbc.co.uk/podcasts/radio4/analysis/rss.xml" link="true" number="1" enclosure="true"

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 16px;">Not strictly Monetary policy but a tool that the Chinese Government uses a great deal to control inflation is prices and incomes policies. These used to be used in the past in Western economies. Basically the government directly controls prices and wages. The Chinese government can do this as inspite of the growth of the market economy, as it still has huge control of the economy.

<span style="font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 18px;">Summary/Revision video on Monetary Policies in the UK media type="youtube" key="RuJ3xc6kAvo" width="420" height="315"