Discuss the view that monetary policy has been the most important factor behind the
recovery of the UK economy in recent years (25 marker)
Monetary policy is an economic policy that uses monetary instruments, like interest rates, to achieve policy
objectives and was used during the great recession, in order to stimulate economic growth and recovery required to
move the economy out of its recessionary stage.
In 2009, the MPC of the Bank of England employed an expansionary
monetary policy, in which interest rates were steeply reduced from 5% in
2007 to 0.5% by 2009, in response to the deepening recession experienced
by the UK. The effects of lowering interest rates are likely to have aided the
UK's economic recovery as decreased interest rates, in theory, lead to greater
consumption. Lower interest rates make it cheaper to borrow, as well as
reduce the financial reward of saving money, which leads to consumers
taking out loans and having a higher propensity to spend, rather than save. In
turn, this leads to an increase in GDP, as consumption attributes 60% of
aggregate demand, thus causing economic growth that is associated with
recovery. This is shown in diagram A, in which an increase in aggregate
demand, shown by the outward shift of the aggregate demand curve from AD1 to AD2, leads to an increase in
national income from Y1 to Y2. Between 2009 and 2010, the percentage changes of consumption increased from -
4.2% to 1.1%, therefore indicating expansionary monetary policy was a factor in the economy's recovery.
In addition, expansionary monetary policy also has an impact on investment spending by firms, as lower interest
rates make it cheaper to borrow money for investment purposes. This is evident in the period of 2009/2010, as the
percentage change of investment increased from –14.4, in 2009, to 5.9% in 2010, indicating that a fall in interest
rates is likely to encourage an increase in investment. Increased investment is likely to have encouraged economic
recovery in both the demand-side and the supply-side of an economy. In the short term, lowered interest rates will
encourage consumption leading to an increased demand for labour, as labour is a derived demand. Therefore, firms
will be encouraged to invest and grow their business, in order to
supply the growing demand for goods and services. In the long term,
increased investment can lead to an improvement in an economy's
productive potential, through an outward shift in the long-run
aggregate supply curve. This is because investment, in theory, is able
to decrease a firm's production costs, allowing them to be more
productively efficient, which can be seen in the diagram (B) as there
is an outward shift of the AS curve, from AS1 to AS2, and a decrease
in the output gap between the LRAS line and the supply curve.
Therefore, increased investment, due to expansionary monetary
policy, leads to a higher long-run trend growth, decreasing the spare
capacity within an economy and fulfilling economic recovery.
Aside from consumption and investment, expansionary monetary policy also leads to an increase in export volumes
which, additionally, aid an economy's recovery. A reduction in interest rates makes it less attractive for money to be
saved in the UK, reducing the demand and the value of the Sterling. Thus, a fall in the exchange rate makes UK
exports cheaper and more competitive and as exports are a component of aggregate demand, an increase in export
volumes leads to an increase in aggregate demand. This was evident
between 2009 and 2010, in which the percentage change of export volumes
increased from –9.8% to 8.7%.
in addition, the impact of increased exports on aggregate demand is seen in
diagram C, in which there is an outward shift of aggregate demand, from
AD1 to AD2, and an increase in national income, from Y1 to Y2. Thus, due to
the subsequent increase in aggregate demand, it is evident that increased
export volumes, due to expansionary monetary policy, can attribute to
economic recovery.
recovery of the UK economy in recent years (25 marker)
Monetary policy is an economic policy that uses monetary instruments, like interest rates, to achieve policy
objectives and was used during the great recession, in order to stimulate economic growth and recovery required to
move the economy out of its recessionary stage.
In 2009, the MPC of the Bank of England employed an expansionary
monetary policy, in which interest rates were steeply reduced from 5% in
2007 to 0.5% by 2009, in response to the deepening recession experienced
by the UK. The effects of lowering interest rates are likely to have aided the
UK's economic recovery as decreased interest rates, in theory, lead to greater
consumption. Lower interest rates make it cheaper to borrow, as well as
reduce the financial reward of saving money, which leads to consumers
taking out loans and having a higher propensity to spend, rather than save. In
turn, this leads to an increase in GDP, as consumption attributes 60% of
aggregate demand, thus causing economic growth that is associated with
recovery. This is shown in diagram A, in which an increase in aggregate
demand, shown by the outward shift of the aggregate demand curve from AD1 to AD2, leads to an increase in
national income from Y1 to Y2. Between 2009 and 2010, the percentage changes of consumption increased from -
4.2% to 1.1%, therefore indicating expansionary monetary policy was a factor in the economy's recovery.
In addition, expansionary monetary policy also has an impact on investment spending by firms, as lower interest
rates make it cheaper to borrow money for investment purposes. This is evident in the period of 2009/2010, as the
percentage change of investment increased from –14.4, in 2009, to 5.9% in 2010, indicating that a fall in interest
rates is likely to encourage an increase in investment. Increased investment is likely to have encouraged economic
recovery in both the demand-side and the supply-side of an economy. In the short term, lowered interest rates will
encourage consumption leading to an increased demand for labour, as labour is a derived demand. Therefore, firms
will be encouraged to invest and grow their business, in order to
supply the growing demand for goods and services. In the long term,
increased investment can lead to an improvement in an economy's
productive potential, through an outward shift in the long-run
aggregate supply curve. This is because investment, in theory, is able
to decrease a firm's production costs, allowing them to be more
productively efficient, which can be seen in the diagram (B) as there
is an outward shift of the AS curve, from AS1 to AS2, and a decrease
in the output gap between the LRAS line and the supply curve.
Therefore, increased investment, due to expansionary monetary
policy, leads to a higher long-run trend growth, decreasing the spare
capacity within an economy and fulfilling economic recovery.
Aside from consumption and investment, expansionary monetary policy also leads to an increase in export volumes
which, additionally, aid an economy's recovery. A reduction in interest rates makes it less attractive for money to be
saved in the UK, reducing the demand and the value of the Sterling. Thus, a fall in the exchange rate makes UK
exports cheaper and more competitive and as exports are a component of aggregate demand, an increase in export
volumes leads to an increase in aggregate demand. This was evident
between 2009 and 2010, in which the percentage change of export volumes
increased from –9.8% to 8.7%.
in addition, the impact of increased exports on aggregate demand is seen in
diagram C, in which there is an outward shift of aggregate demand, from
AD1 to AD2, and an increase in national income, from Y1 to Y2. Thus, due to
the subsequent increase in aggregate demand, it is evident that increased
export volumes, due to expansionary monetary policy, can attribute to
economic recovery.
