Summary AQA A-Level Economics Monetary Policy Notes

Monetary Policy IMPORTANT MATERIAL

MAIN FUNCTIONS OF A CENTRAL BANK

1) Monetary Policy

2) Financial Stability and Regulatory function
-supervising wider financial system and implementing prudential policies designed to maintain
financial stability

3) Policy operations functions
-lender of last resort, managing liquidity in commercial banking, overseeing payments systems

4) Debt Management
-handling issuing and redemption of issues of government debt


IMPORTANT- MONETARY POLICY TRANSMISSION MECHANISM

E.g. A reduction in the bank rate by the BoE

Individuals and Households:

-Less incentive to save --> Reduction in saving --> Increased consumption --> Increased AD
-Cost of new borrowing less --> Increased borrowing --> Increased consumption --> Increased AD
-Cost of existing borrowing less --> Real disposable income increased --> Increased consumption -->
Increased AD


Firms:

-Less incentive to save --> Reduction in saving --> Increased investment --> Increased AD
-Cost of new borrowing less --> Increased borrowing --> Increased investment --> Increased AD
-Cost of existing borrowing less --> Increased retained profits --> Increased consumption --> Increased
AD--> Increased capacity requirement due to increased demand --> Increased investment --> Increased AD


Net Exports

-Hot money outflows --> Reduction in demand for £ (diagram) --> Depreciation of £ --> Exports cheaper,
imports more expensive --> Increased exports, less imports --> Improved net exports --> Increased AD


Impact on SRAS

-Hot money outflows --> Lower demand for £ --> Depreciation of £ --> Imports more expensive -->
Increased cost of production --> SRAS shifts left (diagram) --> Increased cost-push inflationary pressures --
> Contraction of AD