Y1/IB 31) Monetary Policy (Interest Rates, Money Supply and Exchange Rate)

monetary policy is another type of demand side policy which has got three branches to it monetary monetary policy can involve manipulates the interest rates it could involve manipulating the money supply in the economy and Lincoln involvement if there's an exchange rate in the economy all three branches you need to know and need to understand but especially interest rates interest rates is the Big Daddy of monetary policy demands our policy yes but ask fiscal policy it also has got an aggregate supply link so let me consider monetary policy we can have again expansionary monetary policy and we can have contractionary monetary policy expansionary monetary policy is any monetary policy that increases aggregate demand whereas contractionary policies at any monetary policy that reduces a current event so a reduction interest rates an increase in the money supply a reduction in the exchange rate all will increase aggregate demand all will shift early to the right they are all examples of expansionary monetary policy vice-versa the examples of contractionary fiscal policy so let's isolate interest rates because they know much other big daddy will also look at when it's applied exchange rate but interest rates very simply defined as the cost of borrowing interest rates obviously the price of money the cost of borrowing money and the rate of return on savings so when interest rates are reduced the cost of borrowing reduces and the rate of return on saving decreases as well you need to be able to start by explaining that you need to show your understandable interest rates mean when interest rates fall these two things happen there is a double edged coin when it comes to interest rates yes they affect the cost of borrowing but it also affects the rate of return on saving you must mention both of those in your exam to school otherwise you're not going to score fully all right but interest rates affects so many different things interest rates and effective demand for loans a reduction interest rates will increase the demand for loans it's now cheaper to borrow money increasing the demand for loans a reduction interest rate will reduce the incentive to save because they're the rates of return on saving reduces so people are going to think well why save my money I'm not going to get much interest on it I'd rather just spend it instead it's in effect a discretionary income discretionary income is just the income left after your taxes and after your key bills so your discretionary income if you have a mortgage is affected by interest rates so during the deep recession in 2008 2010 interest rates for an or point five percent for a long long period of time and those with mortgages benefited massively because the interest rates that they have to pay on their mortgage of interest repayments plummeted which meant that they actually have more income each month so affects them too it affects it really comes of those with savings so if interest rates fall again people with savings living at less of return which reduces their overall income it affects the demand for housing because as we know most people buy houses and in the UK and in most major Western economies they bear houses by taking out a mortgage taking out a loan on the house and all they do it's month they pay back interest from and then having interest each month that actually pays back the mortgage so if interest rates are very low it's going to potentially increase the demand for houses because now the interest repayment on mortgages is actually very low so incentivizes people to buy houses which increases the demand for houses increases house prices there's another impact of low interest rates but it also an effective exchange rate if you don't understand now watch my video on exchange rate and change its view to understand how interest rates can also affect the exchange rate and very simply whatever happens to interest rates the same will happen to the exchange rate so if interest rates fall the extrange rate is also going to fall the simple reason is because hot money flows hot money will leave the economy in this case that's it UK therefore the value of the pound is going to depreciate the supply the pound increases so exchange rate will also change when the exchange rate changes the effect on the trade performance will also in this case improve if the exchange rate weakens net exports will increase therefore increase inaccurate demand you noticed and that was my video an exchanger impacts to fully understand okay right so expansionary monetary policy or any monetary policies that will increase aggregate demand so it could be a reduction a reduction in interest rates or shift aggregate demand to the right it might be an increase in the money supply m/s an increase in money supply will also increase aggregate mode shift is the right it might be a reduction in the exchange rate it's hard to manipulate the exchange rate so manipulates the exchange rates vary to mind a branch of monetary policy but in theory anyway or reducing the exchange rate movement reducing interest rates maybe by the government actually meddling in the foreign exchange market even though governments these days don't have much control over monetary policy if they did they can meddle in the foreign exchange market and actually allow that exchange rate default increases supply their currency by buying more foreign currencies causing the exchanger to depreciate but really ease to the big ones interest rates and money supply and these are all examples of expansionary monetary policy well however if demand will shift to the right contractionary monetary policy is anyone injured policy valve shifted to the left so the opposite of these will shift is the left and contract the economy will reduce growth and increase unemployment in this case with expansionary monetary policy growth increases unemployment Falls there isn't a member of inflation as well which might as a result worse in the current position of balance of payments there is also a long-run aggregate supply impact so yes this is a demand side policy but there is also a supply side effect here because a reduction in interest rates can also increase investment in fact a thermistor here all vehicles in demand for loans but firms also are impacted by lower interest rates their cost of borrowing for them Falls so they're more likely to borrow money to fund investment projects if firms do that they borrow money and they pour that money to the purchase of capital goods that's going to increase investment and an increase in investment yes will increase aggregate demand in the short run but will also increase an aggregate supply in bottom run aggregate supply as the constantly quality of capital improves so you know when interest rates fall you can expect there to be an increase in investment too which will increase in long-run aggregate supply so don't forget the dual effect you've got an increase in a great demand yes from reduction interest rate but also an increase in long languorous supply because of an increase in investment do not forget the dual effect one final point I'm going to say is that central banks tend to be in charge of monetary policy around the world central bank is like the Bank of Japan the Federal Reserve in America the European Central Bank in the eurozone the Bank of England in the UK these central banks are the the people that control what happens to monetary policy this tends not to be in government control fiscal policy yes it is but monetary policy no it's in the hands of central bank's and within central bank's you have got committees who decide what's going to happen to interest rates so the monetary policy committee of the Bank of England in the UK decide what's going to happen to interest rates each month then just deciding really notice a non 1 month will be great interest rates fall will be pretty interested rise or whatever no that's just completely bogus they actually target inflation when they set interest rates so in the UK the target rate of inflation is 2% so what the monetary policy committee do is when they feel inflation is getting out of control maybe it's getting too high 5% or something they can increase interest rates reduce the length of a great amount of the economy and reducing patient and if inflation is too low they can reduce interest rates and increase aggregate demand and cause more inflation to get inflation back to target so they target inflation and there are two main benefits of inflation targeting which you need to there as well one is that it keeps inflation expectations on the control which means that random consumer consumption habits I'm not going to cause sharp changes in inflation so if you keep a trap keeper a check on inflation expectations consumers won't bring forward a consumption expecting shoot inspect expecting large increases in inflation therefore inflation will always be kept under control so inflation expectations keeps a lid on you know big changes in consumption which we don't receive and at the same time another benefit is that by time T inflation and people by people expect the inflation to be love it allows the central bank to keep interest rates low so if they manage to successfully target inflation it means they've got more reason to keeping interest rates down which therefore will stimulate aggregate demand the economy may be out of supply as well which is good for the economy T so there's a lot of your policy my next video is going to look at the evaluation of monetary policy pay attention in that to get the full SI plan thanks very much see you then

Channel: EconplusDal

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Keywords: Interest Rate (Quotation Subject), Monetary Policy (Literature Subject), Money Supply, Exchange Rate, Money (Video Game Subject), Monetary, Policy, OCR, AS, Macroeconomics, EconplusDal, Econplus, Dal, Virang, Money (Quotation Subject), Market, Economy, IB, Economics, IB Economics

Id: -MH823Imwso

Length: 9min 35sec (575 seconds)

Published: Thu Apr 17 2014