Monetary policy
Introduced| English | Meaning |
|---|---|
| central bank/ˈsentrəl bæŋk/ | The institution responsible for a country's monetary policy and the management of its currency and banking reserves. |
| borrowing/ˈbɒrəʊɪŋ/ | Obtaining money or resources from another party with an obligation to repay them. |
| monetary policy/ˈmʌnɪtəri ˈpɒlɪsi/ | Actions by a monetary authority to influence interest rates, credit or money conditions in pursuit of economic objectives. |
| interest rate/ˈɪntrest reɪt/ | The interest charged or paid over a period, expressed as a percentage of the relevant principal. |
| money supply/ˈmʌni səˈplaɪ/ | The stock of money available in an economy at a particular time, measured using a specified definition. |
| exchange rate/eksˈtʃeɪndʒ reɪt/ | The price of one currency expressed in units of another currency. |
| base interest rate/beɪs ˈɪntrest reɪt/ | base interest rate |
| inflation target/ɪnˈfleɪʃn ˈtɑːɡɪt/ | A stated rate or range of price-level growth that monetary policy aims to achieve over a specified horizon. |
| investment/ɪnˈvestmənt/ | Spending on assets intended to provide future returns or increase productive capacity. |
Why might a cheaper loan leave a factory idle?
- A central bank cuts its policy rate, but a factory still has few orders. Cheaper borrowing 借贷 can help, yet the owner may not buy another machine while existing machines are idle.
- Monetary policy 货币政策 influences interest rates, the money supply and exchange rates to help manage the economy. Explain the route from a policy change to spending, output, jobs and prices, including where the route can be weak.
Separate the policy rate from each bank's rates
- The central bank 中央银行 sets or influences a policy interest rate, often called the base interest rate 基准利率. An interest rate 利率 is the cost of borrowing or reward for saving, stated as a percentage for a period. Commercial banks set their own loan and deposit terms; they need not copy every policy change immediately or by the same amount.
- Money supply 货币供给 is the stock of money available in the economy, including cash and bank deposits. It is not the government's spending budget. An inflation target 通胀目标 can guide policy, but central-bank mandates vary; policy also affects growth, jobs and other macroeconomic aims.
The institution influences financial conditions; each customer's contract helps determine when repayments change.
Monetary policy is typically carried out by the:
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The central bank sets or influences policy rates and monetary conditions. Commercial lenders set the terms of individual loans.
Keeping inflation low and stable can be one aim of monetary policy.
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True. Stable prices can be an aim, but institutions and mandates vary, and policy also affects output, employment and trade.
The interest rate set by the central bank is called the ______ rate.
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The base or policy rate influences other rates. Commercial lenders still set their own terms and do not all adjust identically.
State the loan assumptions before calculating
- For a simple illustration, compare a full year at each rate on an unchanged £20,000 loan balance. Ignore fees, compounding and principal repayments. Interest at 6% is £20,000 × 0.06 = £1,200. If the lender cuts this loan rate to 4%, annual interest is £800, a £400 reduction. The rate fell by 2 percentage points, not 2% of its former value.
- This saving applies only if that loan rate changes. A borrower with a rate fixed at 6% for the whole year still pays £1,200 interest under these assumptions. A variable-rate contract may change sooner. Actual mortgage instalments can include principal and follow different contract rules.
A loan balance stays £40000 for one year at 5% simple interest. Ignore fees, compounding and principal repayments. What is the annual interest (£)?
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£40000 × 0.05 = £2000. This is interest only, not a full mortgage instalment.
Compare a full year at 8% with a full year at 6% on an unchanged £27000 loan balance. Ignore fees, compounding and principal repayments. How much annual interest is saved (£)?
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At 8%, interest is £2160; at 6%, £1620. Saving = £540, or £27000 × 0.02.
A loan rate falls from 9% to 6%. How many percentage points is the reduction?
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9 − 6 = 3 percentage points. The relative percentage fall would be 3 ÷ 9 × 100, so do not call this a 3% relative cut.
A loan contract fixes its rate at 5% for the next two years. The central bank cuts its policy rate today. With no contract change, which conclusion is justified?
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The contract governs this existing rate. New or variable-rate loans can respond differently, and refinancing has its own terms.
Follow a rate cut through the economy
- If banks pass on a lower rate, some loans become cheaper and saving may be less rewarding. Households may spend more, and firms may increase investment 投资 in equipment when expected sales justify it. More spending raises orders for goods and services.
- With spare workers and machines, firms may increase output and jobs. Near capacity, more of the effect may be higher prices instead. Weak confidence, existing debt or unwilling lenders can limit the response; a rate cut does not guarantee more borrowing or employment.
From a rate cut to jobs or prices
Follow the worked 6% to 4% loan-rate example, then check the conditions.
Lower interest rates tend to:
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Cheaper borrowing can encourage spending and investment if banks lend and households/firms want to borrow. Confidence, existing debts and spare capacity matter.
A factory has many idle machines and expects few orders. Its bank offers a loan at 4% instead of 7%, but also requires more security. Explain why investment may not rise, and name evidence needed before predicting job growth.
Use the stated assumptions, explain the causal chain and qualify the judgement with the case evidence.
Explain the reverse move and its trade-off
- Higher loan rates can discourage new borrowing and increase costs for borrowers whose rates adjust. More attractive saving can postpone spending. Lower demand may ease demand-pull inflation, but can also slow output and raise unemployment.
- Some savers receive more interest income and may spend part of it, so households do not all respond alike. Fixed-rate contracts delay effects, and investment and spending decisions take time. A higher rate cannot directly repair a fuel shortage or give workers missing skills.
If excessive total demand is driving inflation, which monetary change tends to cool spending?
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Higher interest rates can discourage borrowing and spending, easing demand-pull pressure. The response takes time and may reduce output and jobs.
Compare a full year at each stated rate, keep all balances unchanged and ignore fees, compounding and principal repayments. A saver has £10000 at a deposit rate rising from 3% to 5%. A borrower has £40000 at a variable loan rate rising from 5% to 7%. Calculate their interest-income/cost changes and explain why their spending responses may differ.
Use the stated assumptions, explain the causal chain and qualify the judgement with the case evidence.
Explain a money-supply change without a shortcut
- More money and easier credit availability can support borrowing and spending if banks lend and households or firms want to use the funds. Reducing money growth or credit availability can restrain spending. These are monetary measures; changing income tax or government purchases is fiscal policy.
- Do not claim that more money must immediately raise every price by the same percentage. People may save it or repay debts, and firms with spare capacity may increase output. The effect on inflation depends on the spending response and how supply can respond.
Which best describes money supply?
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Money supply is a stock of money. Government spending/tax decisions are fiscal policy; physical capital is not money supply.
Include the exchange-rate route
- The exchange rate 汇率 is one currency's price in another. Higher domestic interest rates may attract funds from abroad, increasing demand for the currency and causing appreciation, other things equal. A stronger currency can make imports cheaper in domestic money and exports dearer to foreign buyers, affecting inflation, orders and jobs.
- Policy can influence exchange rates, but a rate rise does not fix a floating currency's value: expectations, risk and foreign rates also matter. If £1 changes from 2 to 1.5 foreign units, a £100 export falls from 200 to 150 foreign units, while a 60-foreign-unit import rises from £30 to £40. Volumes still depend on buyers' response, quality and supply.
The domestic currency depreciates. Assume export prices in domestic money and import prices in foreign money stay unchanged. Which initial price effect follows?
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Depreciation changes currency-converted prices under the stated assumptions. Demand, supply and non-price factors determine the later volume and employment effects.
An export costs £80. The exchange rate is £1 = 1.8 foreign units. What price does a foreign buyer pay (foreign units)?
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£80 × 1.8 = 144 foreign units. Keep the currency quote and units clear.
An import costs 90 foreign units. The exchange rate is £1 = 1.5 foreign units. What is the price in pounds?
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90 ÷ 1.5 = £60. Divide because each pound buys 1.5 foreign units.
Choose a response from the cause
- If spending is pushing beyond capacity and inflation is high, tighter monetary conditions may reduce pressure, at a cost to some borrowers and employment. If spending is weak and workers are idle, easier conditions may support demand, unless confidence or lending is the main constraint.
- Compare benefits, costs and timing before recommending a change. Imported-cost inflation with high unemployment creates a harder choice than excess-demand inflation. A mix with relevant supply-side measures may help, but costs resources and is not an instant cure.
Inflation is 7%, factories are close to capacity and consumer spending is rising quickly. Explain how a rate rise might help, then discuss one cost and one reason its effect could be delayed.
Use the stated assumptions, explain the causal chain and qualify the judgement with the case evidence.
Write a chain with a condition
- Identify the policy instrument, then explain the likely change in bank rates, available money or the exchange rate. Link this to spending or trade, then output, employment and prices. Use “may” or “tends to” where the response depends on a stated condition.
- Use the case figures and distinguish a policy rate from a contract rate. For evaluation, name a different affected group, a delay or a supply/credit constraint, then explain how it changes your judgement. A cheaper loan alone does not prove a new machine will be bought.
Guided revisit: a central bank cuts its policy interest rate from 6% to 4%. Who sets that rate? Explain a likely borrowing/spending channel and a condition that could weaken it.
A lower policy rate can influence borrowing costs, but the effect depends on pass-through and decisions.
Review the same policy-rate cut from 6% to 4%: if lenders pass it on and borrowers respond, what tends to happen?
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Lower loan costs can encourage borrowing and spending under these conditions; fixed contracts and weak confidence can delay or weaken it.
Two economies both have inflation of 6%. In A, spending is rising beyond production capacity. In B, demand is weak, unemployment is high and imported energy has become dearer. Assess whether the same large rate rise is equally suitable in both.
Use the stated assumptions, explain the causal chain and qualify the judgement with the case evidence.