MONETARY POLICY

What is it?  The use of interest rates and the money supply to control aggregate demand in the economy.

Interest Rates  Interest rates can affect aggregate demand in an economy.  How is that possible?

Interest Rates  In the U.K. The interest rates are set by the monetary policy commitee.  In the U.S. they are set by the Federal Reserve.

Interest Rates  The rate at which a central bank or commitee offers is called the base rate.  When this is changed most other interest rates in the economy are changed as well.

Consumption  When interest rates fall, the demand for goods will rise.  People are more likely to take out loans to make purchases.  Home mortgage payments may go down.

Consumption  When interest rates are low people have less incentive to save their money.

Investment  Firms will invest more in new ideas or investments.  The loans the firms already have will cost less, lowering their cost of business.

Exports and Imports  When the interest rates fall, the exchange rate is likely to fall.  The price of exports becomes cheaper.  The price of imports increases.

Inflation  Monetarists believe that inflation is caused by a rapid increase in the money supply.  They believe inflation can be kept low by a tight money supply.

Unemployment  A government may use a loose monetary policy to reduce unemployment.

Economic Growth  Monetary policy can be used to deal with fluctuations in the economic cycle.  Lowering interest rates may stimulate economic growth.

The Current Balance  To reduce a deficit, a country may tighten their monetary policy.  This would reduce aggregate demand and reduce spending on imports.