3.5 Demand Management: Monetary Policy (DP IB Economics: SL): Flashcards
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Define demand-side policies.
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Cards in this collection (28)
Define demand-side policies.
Demand-side policies are policies that aim to shift aggregate demand (AD) in an economy.
Define monetary policy.
Monetary policy involves adjusting interest rates and the money supply so as to influence aggregate demand.
Which institution is usually responsible for setting monetary policy?
Central Banks are usually responsible for setting monetary policy.
Define fiscal policy.
Fiscal policy involves the use of government spending and taxation to influence aggregate demand.
What macroeconomic objectives does monetary policy aim to achieve?
Monetary policy aims to achieve a low and stable rate of inflation, low unemployment, reduced business cycle fluctuations, long-term growth and a stable net external balance.
True or False?
Monetary policy can typically be adjusted more quickly than fiscal policy.
True.
Central Bank committees usually meet 4-8 times a year, whereas fiscal policy is usually adjusted only once a year in the government budget.
Define real interest rate.
The real interest rate is the nominal interest rate minus the rate of inflation.
What does the nominal interest rate represent?
The nominal interest rate is the headline rate presented by commercial banks that has not been adjusted for inflation.
If the nominal interest rate is 3% and inflation is 2%, the real interest rate is .
If the nominal interest rate is 3% and inflation is 2%, the real interest rate is 1%.
Which tools can be used to conduct expansionary monetary policy?
Expansionary monetary policy includes reducing interest rates, increasing quantitative easing, or depreciating the exchange rate.
True or False?
Expansionary monetary policy aims to shift aggregate demand to the left.
False.
Expansionary monetary policy aims to shift aggregate demand to the right; it is contractionary policy that shifts AD to the left.
Which tools can be used to conduct contractionary monetary policy?
Contractionary monetary policy includes increasing interest rates, decreasing or stopping quantitative easing, or appreciating the exchange rate.
Aggregate demand is calculated as AD = C + I + G + (X - ).
Aggregate demand is calculated as AD = C + I + G + (X - M), where M is imports.
Define fractional reserve banking.
Fractional reserve banking is the process of money creation by commercial banks, involving a cycle of lending and deposit creation.
How does fractional reserve banking increase the money supply?
Through repeated rounds of lending and deposit creation, an initial deposit is multiplied into multiple deposits across the banking system, increasing the money supply.
Define open market operations.
Open market operations refer to the buying and selling of government securities, such as bonds, by the Central Bank in the open market.
True or False?
When the Central Bank sells government bonds, interest rates tend to fall.
False.
Selling government bonds reduces commercial bank reserves and lending capacity, which tends to raise interest rates.
How does the Central Bank buying government bonds affect the money supply?
When the Central Bank buys government bonds it injects money into the system, so the money supply increases.
Define minimum reserve requirements.
Minimum reserve requirements are regulations set by the Central Bank mandating the minimum percentage of customer deposits that commercial banks must hold as reserves.
When banks are required to hold a reserve ratio, they have less money available to lend and the money supply decreases.
When banks are required to hold a higher reserve ratio, they have less money available to lend and the money supply decreases.
Define base rate.
The base rate is the interest rate at which the Central Bank lends money to commercial banks, and it acts as the benchmark for interest rates generally.
Give one strength of monetary policy.
Central Banks can operate independently from the government, allowing them to take the long-term outlook into account.
Define transmission mechanism.
A transmission mechanism is the ripple effect through the economy caused by a change such as an adjustment to the base rate, with an activator and several steps leading to an outcome.
The base rate is also known as the rate.
The base rate is also known as the official rate.
Define quantitative easing.
Quantitative easing (QE) is a monetary policy tool in which the Central Bank creates new electronic reserves to purchase government bonds and stimulate the economy.
True or False?
Quantitative easing and open market operations are identical.
False.
In QE the Central Bank creates new electronic reserves ('prints' new money), whereas traditional open market operations use existing reserves.
When is quantitative easing typically used?
QE is typically used when interest rates are already near zero and traditional policy measures are insufficient to stimulate the economy.
Why might expansionary monetary policy be ineffective when confidence is low?
Consumers may not respond to lower interest rates when confidence is low, so aggregate demand may fail to rise as intended.
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