Monetary Policy – GCSE Economics OCR Revision

Understanding Monetary Policy

Monetary policy refers to the methods used by a country’s central bank to control the supply and availability of money.
It is a significant tool used by governments to manage economic fluctuations and to achieve economic stability.
Monetary policy acts alongside fiscal policy, with the latter involving alterations in government revenue and spending.

Expansionary monetary policy is when a central bank increases the money supply or reduces interest rates. These actions aim to boost economic activity and growth by making borrowing more affordable.
Contractionary monetary policy involves the central bank reducing the money supply or increasing interest rates. This can help to slow down an overheating economy and manage inflation.

Investment and consumption: Lower interest rates can stimulate spending and investment since the cost of borrowing is reduced.
Currency value: Monetary policy can affect the exchange rate of a country’s currency, which can impact imports and exports.
Inflation: By controlling the money supply, monetary policy can be used to manage inflation by ensuring the value of money is stable.

Economic growth: Expansionary monetary policy can stimulate growth by making it cheaper for businesses to borrow and invest.
Full employment: Lower interest rates can encourage investment in new businesses and expansion of existing ones, potentially leading to job creation.
Inflation: Central banks can maintain price stability and control inflation by adjusting the money supply.
Balance of Payments: Effective monetary policy can stabilise the exchange rate, which influences the balance of payments by affecting the cost of exports and imports.

Time lags: The impacts of monetary policy changes often take time to fully materialise.
Ineffectiveness in a ‘liquidity trap’: In situations where interest rates are very low or at zero, monetary policy may not be effective in stimulating the economy.
Risk of creating asset bubbles: Expansionary monetary policy may lead to excessive lending, potentially causing asset bubbles and financial instability.