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Chapter 4

6.2 Monetary policy options

 Monetary policy refers to the management of the money supply, via

– Changing interest rates

– Directly affecting the money supply using open market operations

– Indirectly affecting the money supply using banks’ reserve requirements

 Monetary policy can be expansionary or contractionary

– Expansionary – e.g. cut interest rates to encourage borrowing and
spending to stimulate the economy and combat unemployment

– Contractionary – e.g. raising interest rates to discourage spending and
reduce AD and combat inflation

 The “money supply” can be measured in different ways, including

– M0 – Notes/coins in circulation and balances at the country’s Central Bank.

– M4 – Notes/coins + all private sector sterling bank/building society deposits

 Open market operations refer to a Government buying/selling bonds

– e.g. issuing Government bonds reduces the money supply

 Interest rate management – see later

 Monetarist economists believe in using monetary policy rather than fiscal policy
(as advocated by Keynesian economists to influence demand) to control the
economy.

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