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Chapter 32 Notes

Monetary policy involves using interest rates and money supply to manage aggregate demand in the economy. It aims to control inflation, reduce unemployment, and promote economic growth, with interest rates significantly influencing consumer and firm behavior. Tools such as quantitative easing are employed when traditional interest rate adjustments are insufficient to stimulate growth.

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88 views6 pages

Chapter 32 Notes

Monetary policy involves using interest rates and money supply to manage aggregate demand in the economy. It aims to control inflation, reduce unemployment, and promote economic growth, with interest rates significantly influencing consumer and firm behavior. Tools such as quantitative easing are employed when traditional interest rate adjustments are insufficient to stimulate growth.

Uploaded by

madarchod7669
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 32

Chapter 2: Monetary Policy


1. What is Monetary Policy?

 Monetary policy is the use of interest rates and money supply to


control aggregate demand (AD) in the economy.

 The money supply = notes + coins + bank deposits.

 The interest rate = price of borrowing money or reward for saving money.

2. How Interest Rates Work

Different interest rates exist due to:

 Competition between banks.

 Secured vs. unsecured loans (secured = lower risk → lower rate).


 Profits for banks (they charge borrowers more than they pay savers).

 Credit cards often have very high rates.

The base rate:

 Set by a central bank (e.g., ECB in the EU, MPC in the UK).

 Affects all other interest rates in the country.

 Used to control inflation and stabilize the economy.

3. Goals of Monetary Policy

 Control inflation (keep it around a target, e.g., 2%).

 Reduce unemployment by stimulating demand.


 Promote economic growth (especially during recessions).

 Manage the current account balance.

4. How Interest Rates Affect the Economy

a) Consumers:

Lower interest rates:

 Cheaper to borrow → more spending (cars, holidays, etc.).

 Lower mortgage payments → more disposable income.

 Saving is less attractive → more spending.

Higher interest rates:

 More expensive to borrow → less spending.


 Higher mortgage payments → less disposable income.

 More incentive to save.

b) Firms:

Lower interest rates:

 Lower costs on loans → higher profits.


 Higher confidence → more investment.

Higher interest rates:

 Higher costs → lower profits.

 Less confidence → reduced investment.

5. Interest Rates and the Exchange Rate

Lower interest rates → lower exchange rate:

 Exports cheaper → more demand for exports.


 Imports more expensive → reduced import demand.

 Net exports rise → aggregate demand increases.

Higher interest rates → stronger exchange rate:

 Exports expensive, imports cheaper → current account may worsen.

6. Quantitative Easing (QE)

Used when interest rates are too low to stimulate growth.

 Central banks buy financial assets from banks (e.g., government


bonds).

 Banks receive more money → more loans → higher aggregate


demand.
 Risk: Inflation, since the money is digitally created (like printing money).

7. Summary of Monetary Policy Effects on Macroeconomic


Objectives:

Objective Policy Used Effect


Raise interest Slows borrowing/spending → reduces
Inflation control
rates price rise
Reduce Lower interest Boosts borrowing/spending → more
unemployment rates jobs created
Lower interest
Stimulate growth Increases demand → higher GDP
rates or QE
Improve current Depends on price elasticity &
Mixed effect
balance exchange rate impact

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