The Impact of Monetary Policy on Macroeconomic Objectives (Edexcel IGCSE Economics)
Contractionary Monetary Policy & Macroeconomic Objectives
Spec point —
2.1.2b
How Does Contractionary Monetary Policy Affect Macroeconomic Objectives?
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When monetary policy decisions are made, it creates a ripple effect through the economy, impacting the macroeconomic objectives of the government
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Specifically, the use of monetary policy aims to achieve
- A low and stable rate of inflation
- Low unemployment
- Reduce economic cycle fluctuations
- Promote a stable economic environment for long-term growth
- To influence the level of exports and imports
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An example of contractionary monetary policy is if the Reserve Bank of Australia raises interest rates from 4% to 4.25%
Impact of Contractionary Monetary Policy on Macroeconomic Objectives
| Macroeconomic Objective | Impact |
|---|---|
| Economic growth | - Economic growth slows down as loans get more expensive - Consumers and firms are less likely to borrow money. leading to a decrease in total demand |
| Low and stable inflation | - Higher interest rates ease inflationary pressure as economic activity contracts - However, borrowing may continue if consumer and business confidence are high |
| Low unemployment | - Unemployment may increase as output is falling and fewer workers are required |
| Stable current account on balance of payments | - The Current Account is likely to worsen as both exports and imports decrease - Exports are more expensive and imports cheaper, but households have less income for imports |
Expansionary Monetary Policy & Macroeconomic Objectives
Spec point —
2.1.2b
How Does Expansionary Monetary Policy Affect Macroeconomic Objectives?
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An example of expansionary monetary policy is the extra €60 billion a month of QE released by the European Central Bank (ECB) during 2016
- This may increase economic growth but also create inflationary pressures
Impact of Expansionary Monetary Policy on Macroeconomic Objectives
| Macroeconomic Objective | Impact |
|---|---|
| Economic growth | - Economic activity increases as loans get cheaper - There is an incentive to borrow money by consumers and firms - This is used for consumption by households and investment by firms, leading to an increase in total demand |
| Low and stable inflation | - Extra money supply may lead to rapid inflation - As the supply of money increases, interest rates decrease and there is is more demand for loans - This can inflate asset prices (houses) in the long term - The interest rate has limitations on downward adjustment - The closer it gets to zero, the less effective changes are |
| Low unemployment | - Unemployment is likely to fall as a result of more consumer borrowing and spending - Firms increase output to meet demand and more workers are required |
| Stable current account on balance of payments | - Inflation causes higher price levels - Higher price levels increase the price of exports, reducing foreign demand - Demand for imports may increase as households have more money to purchase foreign goods |
Exam Hint When analysing monetary policy, it is worth noting that monetary policy can be adjusted more frequently (4–8 times per year) than fiscal policy (usually once per year). However, the impact of fiscal policy is more predictable than the impact of monetary policy. For example, households may not borrow more money if their confidence in the economy is low, irrespective of how much interest rates fall.
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